Eye on the Economy - 03/09/2005 (Plain Text Version)By David F. Seiders, NAHB Chief Economist View Graphical Version | Subscribe to NAHB Publications | Email our Editor... Growth of U.S. economic output moves ahead nicely …On Feb. 25, the Commerce Department raised its estimate of GDP growth for the fourth quarter of 2004, from 3.1% to 3.8%, placing that quarter comfortably within the healthy above-trend range in evidence for the past seven quarters. The upward revision reflected upward adjustments to exports, construction spending, and business investment in equipment and software as well as inventories. Available monthly data point toward maintenance of strong growth of real GDP in the first quarter of this year (we’re currently estimating 4.0%). Current growth is well balanced, with positive contributions coming from consumer spending, residential and nonresidential fixed investment, inventory investment, government spending and possibly even net exports. While the sectoral composition will be changing in the future, we’re looking for maintenance of solid GDP growth throughout the 2005-2006 forecast period. Job growth continues apace and there’s still ample slack in labor markets …The employment report for February was quite positive. Payroll employment was revised up slightly for the previous two months and then rose by a robust 262,000 in February. Part of this surge represented a catch-up following a negative weather effect in January, leaving an average monthly gain of 197,000 for the first two months of the year. The Labor Department’s survey of households showed a modest decline in civilian employment and a decent increase in the civilian labor force in February. The unemployment rate moved up from 5.2% to 5.4% in the process, leaving the January-February average at 5.3% — equivalent to our projection for the first quarter. The labor force participation rate held steady at 65.8%, a 16-year low. The current unemployment rate suggests that there’s still a good bit of slack in the labor market, leaving room for more above-trend economic growth without serious labor cost pressures, and the low labor force participation rate also argues in that direction. Indeed, broad measures of slack (including discouraged workers, others marginally attached to the labor force and those working only part time for economic reasons) show much more breathing room than the basic unemployment rate. [return to top] Core inflation still is forming up but the signals are hardly alarming …Core inflation (excluding prices of food and energy) certainly has firmed up since late 2003, although the readings for late-2004 still were historically low ― particularly for an economic expansion with three full years under its belt. The core Consumer Price Index (CPI) for January showed a year-over-year advance of 2.3% and the technically superior chain-core CPI was up by 1.9%. While still historically low, these readings are consistent with the systematic upward pressures evident since late 2003 when these core rates were hanging around 1%. Reasonably reassuring news on core inflation recently was provided by the Fed’s favorite inflation gauge, the core price index for Personal Consumption Expenditures. While this measure rose at an annual rate of 3.7% in January, the largest month-to-month jump of the current economic expansion, the year-over-year gain was only 1.6% — similar to the pace of other recent months. Furthermore, a market-based version of this index (excluding most implicit prices) held at 1.7% for the third month in a row. [return to top] Greenspan signals ongoing increases in short-term interest rates …Fed Chairman Alan Greenspan delivered the Federal Reserve’s semiannual Monetary Policy Report to the Congress on Feb.16 (to the Senate) and Feb. 17 (to the House of Representatives). Greenspan painted an optimistic picture of the current condition of the economy as well as near-term prospects. In general, Greenspan talked about solid economic fundamentals, good economic growth, declining unemployment and modest increases in core measures of consumer prices. Greenspan certainly didn’t spell out the future path of monetary policy at his Feb. 16-17 testimony before Congress. However, a judicious reading “between the lines” reveals a strong preference for more tightening in the near term as well as further down the line. In this regard, Greenspan described the current federal funds rate as “fairly low” despite significant tightening since mid-2004, and he made several references to excessive risk-taking in financial markets. He also focused on upside risks to core inflation, including the cyclical slowing of productivity growth and the prospects for further declines in the dollar and associated increases in import prices. Financial markets are pricing in expectations of another percentage-point increase in the federal funds rate by August, taking the funds rate to 3.5% and the bank prime rate to 6.5% by then. NAHB’s forecast shows a 3.75% funds rate by year end, and we expect the Fed to push the rate to 4.25% by mid-2006 as it pursues a neutral policy stance that will neither stimulate nor retard the economic expansion. [return to top] Long-term interest rates may finally be on their way up …When Greenspan marched to Capitol Hill on Feb. 16, the 10-year Treasury bond yield was hanging around 4.1%, well below the levels of mid-2004 despite the Fed’s 150 basis point hike in short-term rates that began on June 30. Greenspan naturally paid a good bit of attention to this apparent disconnect and pointed out that the phenomenon actually is global. In essence, he threw up his hands and said “the broadly unanticipated behavior of world bond markets remains a conundrum” ― i.e., a riddle with no satisfactory solution. Although Greenspan was hard-pressed to explain the behavior of long-term rates, it seemed clear that he was not entirely happy with their stubbornly low levels. Greenspan’s vibrations apparently made their way into the bond markets, and the 10-year Treasury yield has gravitated back about 4.35%, in alignment with NAHB’s forecast for this point in time. We also continue to believe that further increases are in store, and we’re pegging the Treasury bond rate at 5% by the end of this year. That move should take the long-term home mortgage rate up to about 6.5%, and we expect a 7% mortgage rate by the end of next year. [return to top] House prices continue to climb, particularly in supply-constrained markets …Rapid increases in house prices have been a striking feature of the economic scene in recent years, and that pattern continued through the end of last year. The repeat-transactions House Price Index (HPI) produced by the Office of Federal Housing Enterprise Oversight (OFHEO) showed a year-over-year increase of 11.17% in the fourth quarter of 2004, down a bit from the third-quarter pace but still in the high end of observations for the history of the series. The national rates of house price appreciation certainly are striking, but the rates for some geographic areas are astounding. Metro areas with the most rapid rates of house price appreciation are heavily concentrated in the West and in The rates of house price increase registered in some areas presumably will not be sustained for long, even though it’s clear that shortages of developable land have created housing shortages in many high-growth areas. Rising interest rates are likely to crimp price increases to some degree, although growing employment and household income will be supporting housing demand at the same time. Everything considered, we’re expecting house price increases to slow down in 2005-2006 without any regional declines. Price declines are possible in some metro areas, particularly those where aggressive buying by investors/speculators may have boosted prices to unsustainable levels. [return to top] The housing outlook is quite positive despite mixed signals early this year …Total housing starts for January posted a 21-year high, single-family starts climbed to a record high and issuance of building permits threatened the records set last May ― and all this happened in the face of unusually bad weather in the Northeast, Midwest and West. Home sales were off in January at the national level (for both new and existing units), but weather-related declines in the Northeast and Midwest regions pulled the numbers down from the records of late 2004. The NAHB/Wells Fargo Housing Market Index lost just a bit of ground in January and February as single-family builders maintained an upbeat view of buyer traffic, current home sales and sales prospects for the future. The index of applications for mortgages to buy homes (Mortgage Bankers Association series) definitely is off the records of late 2004, but the series still is within the range of the last 18 months and recent declines may be partly weather related. Our forecasts for the economy and the financial market environment paint a friendly picture for housing in 2005 and 2006. We’re showing modest (3%-4%) declines in home sales and housing starts in both years, countered to some degree by persistent growth in residential remodeling and an evolving upswing in manufactured home shipments. The balance of forces generates slight declines in the housing production component of GDP (residential fixed investment) over the next five to six quarters, following positive growth during the past several years (including the first quarter of this year). [return to top] Register for the Spring Construction Forecast Conference.See what's on the horizon for the housing industry at NAHB's Spring Construction Forecast Conference on May 5 in Washington, D.C. Get the latest forecasts on housing starts, project budgets and other economic bellwethers and developments in the housing industry from some of the country's premier economists and finance experts. To register or for more information, click here. [return to top] 'HousingEconomics Online' provides in-depth analysis of housing market.HousingEconomics Online" is NAHB's new online publication from the NAHB Economics Group that provides the latest housing economic data, trends and key events that shape the economy. NAHB’s leading economists analyze and synthesize the housing and economic information to provide in-depth analyses of the niches and nuances of the home building market. 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