Eye on the Economy: The Fed Now Appears to Be on Hold
Commerce Department revisions to first-quarter real Gross Domestic Product show slightly stronger economic growth as well as somewhat better balance in the composition of growth. GDP growth was revised from 0.6% to 0.9% (annual rate) and final sales (excluding business inventory investment) now show growth of 0.7% rather than contraction of 0.2%.
An improvement to our trade balance was the key factor behind the upward revisions to first-quarter GDP and final sales, and business spending on nonresidential structures also was revised up significantly.
Residential fixed investment (RFI) was revised up slightly but remained the weakest component of the first-quarter GDP report, contracting at an annual rate of 25.5% and subtracting 1.2 percentage points from the GDP growth rate.
The performance of RFI was essentially the same as the dismal performance in the final quarter of last year, and the setback extended the housing contraction to nine consecutive quarters.
Competing Forces Point Toward a Flat GDP Pattern in the Second Quarter
Housing promises to remain a major drag on GDP growth in the second quarter ― we’re estimating RFI contraction at a 22% annual rate ― and we’re likely to see some contraction in nonresidential fixed investment as well.
The biggest question mark in the second quarter relates to personal consumption expenditures (PCE), which account for about 70% of overall GDP. Real PCE growth slipped to 1% in the first quarter and strong opposing forces are pulling on consumer spending in the current quarter.
The rebates of personal income taxes that began in the latter part of April will have some positive impact on consumer spending in the second quarter. On the other hand, high food prices and record-high energy costs are acting like taxes on consumers and could neutralize positive effects from the income tax rebates.
Indeed, Conference Board measures of consumer confidence and University of Michigan measures of consumer sentiment have been falling rapidly, reflecting high food and energy costs, falling house prices and a weakening job market.
We expect the balance of forces to push PCE growth toward zero in the second quarter, and we’re projecting zero growth in overall GDP for this quarter.
We still expect economic growth to strengthen in the second half of the year, although the range of risk around that forecast is unusually wide.
Rising Commodity Prices Stoke Inflation Concerns
Slowing national and global economies, by their nature, should relieve fundamental inflation pressures and create room for monetary ease by U.S. and foreign central banks. But we’re now facing dramatic upward pressures on global commodity prices, primarily food and energy, which inevitably will leak into the core price measures that central banks really worry about.
The commodity price inflation apparently is boosting inflation expectations among consumers and businesses to some degree, despite weakening labor markets and containment of unit labor costs. On this front, the Fed and some foreign central banks — including the European Central Bank and the Bank of England — are increasingly worried about rising commodity prices becoming a factor in wage-setting and business-pricing behavior during the period ahead.
The Fed Now Appears to Be on Hold
Minutes from the April 29-30 meeting of the Federal Open Market Committee (FOMC) reveal projections by policymakers that show strengthening growth of real GDP beyond mid-2008. The projections also show expectations of retreating core PCE inflation next year, following some increase in the second half of this year due to spillovers from the commodity markets ― primarily energy.
The tone of the FOMC minutes strongly suggests that the Fed will soon halt the process of rate cuts that has brought down the federal funds rate by 325 basis points since last August and that has reduced the discount rate by 400 basis points over that span of time.
This easing process has brought the real funds rate slightly into the negative range, of course, and that’s certainly a stimulative monetary policy stance.
NAHB’s forecast now assumes the Fed will maintain the current 2.0% federal funds rate target at the next FOMC meeting on June 24-25. We also believe that this position will be held until the second quarter of 2009, followed by a march back toward monetary neutrality as economic growth gets back to trend.
Long-Term Interest Rates Are Firming Up
The reassuring news on economic growth, along with higher inflation concerns and shifting expectations about monetary policy, have caused long-term interest rates to firm up from recent lows in April. The 10-year Treasury yield has moved up by more than 50 basis points over this period and now stands above 4% for the first time since the end of 2007.
Rates on prime conforming fixed-rate home mortgages have firmed up to some degree since early April, although the increase has been much less than in the long-term Treasury market. This reflects a welcome narrowing of risk spreads between Treasuries and comparable-maturity securities issued or guaranteed by the secondary market GSEs — Fannie Mae and Freddie Mac.
We expect long-term mortgage rates (prime conventional conforming) to hang around 6% during the next several quarters, and rates on FHA-insured loans will be even more favorable. In terms of mortgage volume, fixed-rate loans that can be sold to Fannie Mae/Freddie Mac or insured by FHA/VA will dominate the scene for some time.
Short-Term Housing Outlook Remains Bleak
Recent housing market indicators — including NAHB’s survey measures as well as incoming data on home sales, housing starts and permits, housing inventories and home prices ― show that the housing market contraction still is underway, and we expect further declines to occur in the economic and financial market environment we’re projecting for the rest of this year and in 2009. That environment includes increasingly difficult conditions in the markets for land acquisition, land development and construction loans (AD&C markets).
In the single-family sector, we continue to believe that home sales will bottom out around mid-2008, that starts of new units will bottom out around the end of this year and that house prices will stabilize by the end of 2009 (national average basis).
We expect starts to be down by 37% for 2008 as a whole, followed by decent recovery in 2009.
We’ve recently cut our forecast of activity in the multifamily sector, based on evidence of a heavy oversupply in the condo component, unsustainable production levels in the rental component (both market-rate and subsidized rental segments), tightening conditions in AD&C markets and a weakening market for low-income housing tax credits.
The revised forecast shows a 7% decline in multifamily starts for 2008, followed by a decline of 22% for 2009.
Our current forecast shows a slight decline in total housing starts for 2009 as a whole, and residential fixed investment contracts through the first quarter of the year.
NAHB Chief Economist David Seiders analyzes the economy from the point of view of the housing market every other week in the free e-newsletter, “Eye on the Economy.” The preceding is a reissue of his May 29 edition. To subscribe to “Eye on the Economy,” click here.
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Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
To help members navigate the uncharted waters of this slowdown, NAHB has compiled a comprehensive “Back to Basics” online toolkit — the best of the basics, the tried and true and the truly new. To access the toolkit, click here.
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