Eye on the Economy: Economy Moving Toward Recovery
Real gross domestic product (GDP) contracted at a 6.2% annual rate in the final quarter of last year, the sharpest contraction since the depths of the 1982 recession. Available evidence on economic activity for the early part of 2009 shows that another major decline in GDP is in the cards for the first quarter of the year. We’re currently estimating -5.5%.
The labor market also is weakening rapidly. Payroll employment has fallen by 2.6 million over the last four months (through February) and the civilian unemployment rate has moved up considerably over that period — reaching 8.1%.
Further deterioration of the labor market is inevitable in March, a pattern revealed by weekly data on new and continuing claims for unemployment insurance.
Housing Production Still Is Weakening
The housing sector, which began to weaken more than two years prior to the onset of national recession at the end of 2007, still is a major negative for the U.S. economy. The housing production component of GDP (residential fixed investment) suffered a severe setback in the final quarter of 2008 and will post an even weaker performance in the first quarter of this year.
Employment in residential construction naturally continues to trail down systematically as housing production continues to weaken, and falling house prices continue to take heavy tolls on household wealth, consumer spending, mortgage credit quality and the national and global financial systems.
The ongoing contractions in residential fixed investment and residential construction employment have reflected serious imbalances between supply on the market and effective demand for both home owner and rental housing units.
There still are very large numbers of vacant housing units on and off the market, but massive cutbacks in new housing production along with prospects for near-term stabilization of home buyer demand should be improving the supply-demand balance before long.
The Economic Recession Now Is Truly Global
The recession increasingly is global in scope and nature, and a rare decline in world real GDP now is a virtual certainty for 2009.
Trade flows are contracting substantially for both developed and emerging economies, and the U.S. now is registering sharp declines in both exports and imports.
Our nominal trade deficit has been falling since last July, partly reflecting lower prices of imports — especially energy. However, the trade sector most likely will make a negative contribution to U.S. real GDP growth in the first quarter of this year, as in the fourth quarter of 2008, due partly to the rise in the dollar since mid-2008.
Inflation Concerns Are Giving Way to Deflation Fears
The global economic recession and growing slack in labor markets have totally defused earlier inflation concerns in financial markets and at our central bank, and the specter of potentially destructive deflation has crept onto the radar screen.
The Producer Price Index for finished goods moved down substantially during the last five months of 2008, and year-over-year changes for January and February were solidly in the red zone. Producer prices at earlier intermediate and crude stages of production have been throwing off large negatives in recent months, and those downward pressures will make their way into the finished goods measure as the year rolls along.
The Consumer Price Index (CPI) has been decelerating markedly since mid-2008 and year-over-year changes for the December-February period were negligible.
The core CPI (excluding prices of food and direct energy) has shown year-over-year gains of less than 2% for the past three months, and the chain-core version allowing for substitution with the market basket of goods and services has been just over 1% — not far from price stability.
The Financial System Still Is Functioning Poorly
The national and global financial market crisis has rightfully earned the title of “Great Recession” for the current economic situation.
Daunting problems in the financial systems pose formidable impediments to near-term economic stability and recovery both here and abroad, despite enactment of large fiscal stimulus packages in the U.S. and elsewhere. This reality was emphasized in a recent meeting of the finance ministers of the G-20 countries in England.
It’s true that extraordinary efforts by the Federal Reserve and foreign central banks have improved the functioning of interbank markets and some short-term credit markets — particularly commercial paper — since the virtual freeze last fall. But our banking system apparently remains seriously undercapitalized despite major injections of TARP funds.
Banks and other major financial institutions still are weighed down by “toxic” mortgage assets, mortgage foreclosure problems still are mounting, and quality spreads in mortgage securities and bond markets, corporate and municipal, are extremely wide.
Under these conditions, private credit markets still are in serious states of disrepair.
The Federal Reserve Pulls Out the Stops
The flagging economy, threat of deflation and persistent problems in the financial sector have spurred the Fed to pull out the policy stops.
The Fed has dropped the federal funds rate from a cyclical high of 5.25% in the second quarter of 2007 to the 0.0%-0.25% range that’s prevailed since the end of 2008, effectively exhausting the major tool of monetary policy.
The Fed also has thrown open the discount window to both banks and primary securities dealers and has waded into both the commercial paper market and the home mortgage market by substantially expanding its balance sheet operations in order to improve credit flows and reduce costs of credit in these markets.
The Fed delivered a lot more support to credit markets at the conclusion of the March 17-18 meeting of the Federal Open Market Committee (FOMC). As expected, the FOMC held the target range for the federal funds rate at 0.0% to 0.25% and committed to hold it there for an “extended period.”
NAHB assumes that this rate will prevail through the end of next year.
Two major unexpected policy moves were announced on March 18. First, the FOMC decided to purchase and hold up to an additional $750 billion of agency mortgage-backed securities and an additional $100 billion of housing agency debt, on top of the $500 billion and $100 billion of agency mortgage-backed security and debt committed to earlier — bringing the overall total for this year to a whopping $1.45 trillion.
The Fed said these moves were taken to provide “greater support to mortgage lending and housing markets.”
The second surprise from the FOMC was a decision to purchase up to $300 billion of longer-term Treasury securities over the next six months, “to help improve conditions in private credit markets.” This essentially amounts to a decision by the Fed to “peg” Treasury rates, apparently in the two- to 10-year range, with the expectation that downward pressure will be put on rates of comparable maturity in private credit markets.
Treasury Supplies More Details on Public-Private Toxic Asset Plan
On March 23, Treasury Secretary Timothy Geithner supplied more details on a critical component of the Obama Administration’s plan for stabilizing the financial system, i.e., the public-private partnership designed to get toxic or “legacy” assets off the books of banks and other financial institutions.
The immediate financial market reaction to Geithner’s detailed plan was quite favorable, in stark contrast to the negative reactions to Geithner’s unveiling of the bare bones of the program in early February.
The new Public-Private Investment Program (PPIP) will set up dedicated funds that will provide markets for both legacy loans and legacy securities. The public and private sectors will invest equal amounts of capital in the funds, and guaranteed debt financing will be provided by FDIC for the loans program or the Treasury for the securities program.
The program is designed to generate price discovery for illiquid loans and securities, largely through auctions of loan pools by the FDIC to private investors. The established price may or may not be acceptable to the financial institutions putting up the loans and securities for sale.
The Treasury clearly has moved this ball well down the playing field, but there’s still some distance to go before the investment funds are set up and transactions are struck. It could be midyear before proper assessment of the PPIP can be made.
AIG Bonus Flap Threatens to Disrupt Public-Private Policy Initiatives
The recent public and political outcries over large “retention bonuses” paid to many executives of AIG, following massive injections of funds into this company by the federal government, threaten to divert the attention of policymakers from critical market needs at exactly the wrong time and to undermine the efforts to contain the financial crisis.
We’re assuming that the political response to retention bonuses paid to executives of AIG and other financial companies receiving substantial federal support, including large commercial banks, will not be severe enough to discourage participation of private capital in efforts by the Treasury and the Fed to salvage the financial system.
But damage has been done, and delicate balances may very well have been jeopardized.
Policy Blitz Moves Economy Toward Recovery
There have been some glimmers of light in the darkening economic picture, including retail sales for January and February and sales of both new and existing homes in February. It’s clear that ongoing market adjustments in key sectors are essential to eventual economic recovery and expansion.
The policy blitz coming from the Administration, Congress, the Federal Reserve and foreign policymakers certainly is helping in moving the train down the track toward the recovery tunnel — and the light at the other end should be in view soon.
NAHB’s baseline (most probable) forecast shows resumption of real GDP growth during the second half of this year, topping-out of the unemployment rate in the first quarter of 2010, resumption of payroll employment growth by the second quarter of next year and inflation rates that approach zero in 2010 but do not slip into the deflationary zone.
This economic recovery pattern cannot materialize without near-term stabilization of the housing sector, and we’re counting on support from recent policy initiatives to help housing turn that corner.
Our forecast shows a bottom for home sales in the first quarter of this year, a bottom for total and single-family housing starts in the second quarter, and a bottom for the residential fixed investment component of GDP in the final quarter of 2009.
National average house prices should stabilize within a few quarters, and the majority of the decline may now be behind us.
NAHB 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 the March 25 edition. To subscribe to “Eye on the Economy,” click here.
Tax Credit Web Site Looks at Opportunity of a Lifetime
Builders and other industry professionals can help spur home sales by referring prospective first-time home buyers to www.federalhousingtaxcredit.com. The NAHB Web site provides detailed information on the $8,000 federal tax credit for first-time home buyers included in the economic stimulus legislation signed into law by President Obama.
Consumers can use the Web site to find information on the tax credit – including a detailed question and answer section. It also includes information about other housing-related and small business measures in the legislation and a number of home-buying resources for consumers.
Spanish Version Also Online
A Spanish version of this increasingly popular Web site is also available to provide detailed information on the tax credit to Spanish-speaking first-time home buyers.
Industry professionals are encouraged to highlight either tax credit Web site when marketing to their potential first-time home buyer market.
Plan to Attend Construction Forecast Conference
Plan to attend or watch the 2009 Spring NAHB Construction Forecast Conference & Webcast on Thursday, April 23 in Washington, D.C. to get the latest facts, insights and analysis of the housing industry.
Panels of nationally recognized experts at the day-long conference will discuss economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys.
For more information and to register, visit www.nahb.org/cfc.
Want to Know the Housing Starts Through 2017?
Find out in HousingEconomics.com's Long-Term Forecast.
Subscribe and get downloadable Excel tables that feature the housing starts forecast, gross domestic product (GDP), demographics and more.
To learn more, visit www.housingeconomics.com.