Eye on the Economy: The Fed Rattles Its Anti-Inflation Saber
Payroll employment fell by 49,000 in May, about as expected, while the unemployment rate jumped to 5.5%, much more than expected.
Payroll employment fell for the fifth consecutive month in May, bringing the cumulative loss so far this year to 324,000 — an average monthly setback of 65,000 jobs. Employment in residential construction fell by 25,000 in May and now is down by 494,000 from its cyclical peak in early 2006.
The civilian unemployment rate jumped by half a percentage point in May and now is 1.2 percentage points above its cyclical trough early last year. This increase was the largest one-month gain in unemployment since the 1980 recession and reflected a very large increase in the labor force ― 577,000 — along with a sizable decline in household employment — 285,000.
The moderate downward trend in payroll employment reveals an economy having slow growth in real gross domestic product (GDP) and healthy growth in labor productivity.
The stunning one-month jump in the unemployment rate could spell much deeper trouble in the labor market, although it appears that a temporary glitch in the numbers ― a flood of students entering the labor market during the survey week — accounted for much of the jump.
Surging Energy Costs Pose Serious Risks to the Economy
Crude oil prices in global markets and gasoline prices at U.S. pumps have risen sharply to record highs in recent days. Persistent upward pressures in recent months have reflected fundamental imbalances between strong global demand and shortfalls in supply, and sharp day-to-day movements generally have reflected shifting speculation about political instability in oil-producing regions of the world.
Surging energy costs endanger the U.S. economy in two ways. First, higher costs act like taxes on households and businesses, sapping purchasing power and cutting into discretionary outlays. Second, rising energy costs boost headline inflation measures and can feed through to measures of core consumer price inflation — to the displeasure of central banks in the U.S. and other industrialized economies.
The current negative “tax” effects of record-high energy costs on real economic activity, particularly on real consumer spending, are occurring in the same time frame as the rebates of personal income taxes that began in May and will extend into the summer months.
The tax rebates, about $110 billion, should more than cancel out the negative effects of the increase in energy costs, protecting the economy from that potential recessionary impulse — at least in the short term.
On the inflation front, the surge in energy costs is occurring at the same time that the labor market is weakening for other reasons, limiting the potential impacts on unit labor costs and core inflation.
A sustained inflation problem will not develop without the participation of the labor market, and we’re actually looking for more slack in labor markets during the next few quarters.
Mortgage Foreclosures Are Surging
Foreclosures on home mortgages have been soaring to record highs, according to the National Delinquency Survey conducted the Mortgage Bankers Association (MBA) for the first quarter of the year. This pattern reflects the lax lending standards that prevailed during the earlier housing boom, the house price declines that have been accumulating during the current housing bust, and rising levels of unemployment as the economy has weakened recently.
MBA’s first-quarter report showed record highs across most loan types for serious delinquencies, foreclosures started and the inventory of loans in the foreclosure process. MBA began compiling this data in 1979.
The most alarming deterioration has been occurring in the subprime component, particularly subprime adjustable-rate mortgages (ARMs), although the quality of prime ARMs now is weakening badly as well. Even prime fixed-rate loans are becoming more troublesome.
The MBA report highlighted the severe deterioration of mortgage credit quality in the states that have been experiencing the most rapid declines in house prices — California, Florida, Nevada and Arizona. These states accounted for 25% of all first mortgages outstanding and 42% of all foreclosures started in the first quarter.
Housing Construction Still Is Heading Downhill
The housing production component of GDP, residential fixed investment (RFI), contracted at an annual rate of 25.5% in the first quarter and subtracted a whopping 1.2 percentage points from the GDP growth rate. That was the ninth consecutive quarterly decline in RFI, following several years of rapid growth during the previous housing boom.
The pattern of housing starts through April virtually guarantees another sizable decline in RFI for the second quarter. In fact, data on residential construction put-in-place during April point in that direction.
We’re currently expecting RFI to contract at a 22% annual rate this quarter, with progressively smaller negative GDP effects through the first quarter of 2009.
The Trade Sector Is Providing Solid Support to the Economy
The U.S. economy has been running a sizable trade deficit for a long time, but real net exports have been providing welcome support to GDP growth during the past year as the trade deficit has narrowed systematically in constant-dollar terms.
Indeed, the support from trade has essentially offset the negative impact from the contraction in residential construction since the second quarter of last year. The slowing U.S. economy, strengthening foreign economies and the lower dollar are behind the recent improvements to real net exports.
The nominal trade deficit widened in April as imports of goods and services grew at an even stronger pace than exports ― 4.5% versus 3.3%. However, the surge in nominal imports largely reflected sharply rising prices for various commodities, particularly imported oil.
Excluding petroleum products, the nominal trade deficit in goods was essentially unchanged while the real deficit, after adjusting for price changes, actually continued to narrow.
Net exports should continue to provide solid support to the U.S. economy over the balance of the second quarter, and we’re counting on ongoing support through early next year as the negative impacts from the housing contraction run their course.
The Fed Rattles Its Anti-Inflation Saber
The minutes from the April 29-30 meeting of the Federal Open Market Committee (FOMC) reveal growing concerns among FOMC members about commodity price inflation and potential implications for core consumer price inflation down the line.
More recently, Fed Chairman Ben Bernanke said the run-up in oil prices “has added to the upside risks to inflation and inflation expectations.” In this regard, Bernanke also said that the surprising jump in the unemployment rate for May hasn’t materially affected the economic outlook.
The Fed now seems preoccupied with the potential impacts of inflation expectations on actual core inflation. On June 9, Bernanke pledged that the Fed “will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.”
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, consistent with market expectations embedded in futures market pricing.
We believe that this position will be held through the first quarter of 2009, followed by a gradual march back toward monetary neutrality as economic growth gets back to trend.
Futures market pricing implies that the Fed will begin raising the funds rate later this year, but we don’t share that view.
The Composition of NAHB’s Housing Forecast Has Been Changed
NAHB’s revised forecast of housing production shows a shift in composition of housing starts from the multifamily sector to the single-family sector. Worsening supply-demand fundamentals have prompted downward revisions to all three components of multifamily — market-rate rentals, subsidized rentals and for-sale condos and co-ops.
Our multifamily forecast now shows 285,000 starts in 2008, down 7% from 2007, followed by a 23% reduction in 2009 to 221,000 units — the lowest since 1993.
The reshaping of the housing starts forecast softens the projected downswing in residential fixed investment to some degree, since single-family starts have larger value-per-unit than multifamily starts.
RFI still moves down though the first quarter of next year, however, and the housing sector continues to pose considerable downside risk to out GDP projections for 2008 and 2009.
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 June 11 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.
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