Eye on the Economy - 03/08/2006 (Plain Text Version)

By David F. Seiders, NAHB Chief Economist

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Economic Growth Is Rebounding Now, But Will Have to Settle Down Soon

As expected, growth of U.S. economic output (real GDP) has been revised up for the fourth quarter of 2005 (to 1.6%), and growth for the year as a whole now stands at a solid 3.5% pace. Furthermore, GDP growth for the first quarter of this year appears to be headed for about 5%, a truly robust pace by any standard.

We’re now into the fifth consecutive year of this economic expansion, and a long run of above-trend GDP growth has generated substantial increases in employment since mid-2003, despite unusually strong growth in labor productivity (output per hour) for most of the expansion period.

Thus, the degree of slack in U.S. labor markets has been systematically reduced and the unemployment rate has come down substantially (to 4.7% in January). Growth of hourly labor compensation has been picking up in the process and labor cost per unit of output has been on the rise as productivity growth has slowed.

Rising unit labor costs create upward pressure on price inflation, and our central bank has made it perfectly clear that containment of “core” inflation (excluding prices of food and energy) is its paramount monetary policy objective. Core inflation has been well contained so far, but the Fed definitely wants growth of real GDP to recede to trend (or slightly below) before long. We’re assuming that the Fed will pursue that objective by enacting another quarter-point increase in short-term rates at the next Federal Open Market Committee (FOMC) meeting on March 28, and yet another rate hike could occur at the May 10 meeting.

We’re projecting average GDP growth of 3.25% during the second half of this year and in 2007, a slightly below-trend performance that should provoke a slight uptick in the unemployment rate and keep core inflation within the Fed’s apparent comfort zone. A moderate downshift in home sales and housing production and a definite slowdown in house price appreciation are key components of the projected slowdown in economic growth.

Long-Term Interest Rates Shift Upward in March

Long-term interest rates have been stubbornly low in recent years despite the large increase in short-term interest rates (3.5 percentage points) implemented by the Federal Reserve since mid-2004. Indeed, long-term bond and mortgage rates actually held below their mid-2004 levels through February, and flat (or inverted) yield curves became commonplace around the globe.

The mood in domestic and global bond markets shifted abruptly in the early days of March, and the 10-year Treasury yield moved up by about 20 basis points in short order (to about 4.75%). The catalyst for change came primarily from abroad as various foreign central banks (including the European Central Bank) raised their interest rate targets and the Bank of Japan talked publicly about putting an end to its long-standing quantitative easing process.

These moves raised questions in the investment community about maintenance of huge flows of global capital into U.S. securities markets, and long-term rates in the U.S. shot up immediately.

The recent up shift in long-term rates has simply returned them to mid-2004 levels. The Treasury yield curve now is essentially flat from six months out, and another quarter-point hike by the Fed at the March 28 FOMC meeting should flatten the short end of the curve. We appear to be headed toward a more sustainable yield structure than we’ve seen for several years and further (modest) increases in long-term rates are likely over the balance of the year. [return to top]

The Orderly Housing Slowdown Becomes More Convincing as Time Passes

Evidence of a gradual slowdown in housing market activity from the frenetic pace of 2005 continues to accumulate. The January spurt in housing starts clearly was weather-related, and sales were down in January for both new and existing homes. Indeed, sales of new homes, sales of existing single-family homes (based on closings), and “pending” sales of existing homes (based on contracts signed) all were down by about 10% from their monthly highs in 2005.

NAHB’s single-family Housing Market Index held steady in January and February following significant erosion during the second half of 2005, and the index of applications for mortgages to buy homes (Mortgage Bankers Association series) has continued to trail down gradually from the recent high last September (four-week moving average basis).

These forward-looking survey measures suggest that the evolving housing slowdown still has some distance to run, but the pattern still is consistent with the orderly “simmering down” process NAHB has been forecasting for some time. [return to top]

Home Price Appreciation Is Slowing, But Affordability Still Is Eroding

House price appreciation apparently topped out around mid-2005, but the slowdown has not yet stemmed the systematic erosion of housing affordability that has sapped the strength of housing demand in recent times.

The purchase-only component of the House Price Index produced by the Office of Federal Housing Enterprise Oversight (OFHEO) is the best available measure of house price appreciation. This measure increased at a year-over-year pace of 10.8% in the final quarter of 2005, down from a peak of 11.5% in the second quarter but still one of the highest rates on record.

The median price of existing single-family homes lost a bit of forward momentum as 2005 drew to a close, but this series still recorded a hefty 13.1% year-over-year advance in January.

The accumulation of rapid house price gains over a period of years, along with a gradual increase in mortgage interest rates since mid-2005, have continued to weigh on affordability in the existing-home market. Indeed, the composite Affordability Index by the National Association of Realtors® was down by 13.3% in January (year-over-year), and that decline followed substantial deterioration in 2004 and 2005. [return to top]

Unsold Inventories of New Homes Are High

According to the Census Bureau, the inventory of new homes for sale reached a record level in January, and the months’ supply (at the January sales pace) moved above five for the first time in almost a decade. Furthermore, the median length of time that completed new homes were sitting on the market moved up to 4.5 months.

The Census Bureau’s new-home inventory estimates include units that are for sale but not yet started, a feature that takes some sting out of the inventory “overhang.” However, the inventory of units completed or under construction also is at a record level. Furthermore, home sales that are subsequently cancelled never get back into the government’s inventory estimates, and it’s clear that cancellations have been on the rise recently.

In February, NAHB surveyed nearly 500 single-family builders about unsold inventories (excluding units not-yet-started and including units handed back to builders through cancellations). More than one-third of the respondents said their inventories were higher than six months earlier, while less than one-fifth said their inventories had come down over that period. The net percentage reporting higher inventories was particularly high in the West and among builders starting more than 25 units per year. [return to top]

Sales Cancellations Also Are on the Rise

In NAHB’s February survey, 20% of single-family builders said their cancellation rate was higher in January than six months earlier, while only 8% said their cancellation rate was down over that period.

Reasons given for cancellations, in order of importance, were:

Buyer could not sell an existing home (45%)
Buyer could not qualify for a loan (33%)
Buyer decided not to purchase a home (33%)
Family circumstances changed (18%)
Change in employment (15%)

A supplementary NAHB canvass of about 30 large single-family home builders showed that, in January, cancellation rates (cancellations as a percent of sales backlog) were up by about one-third, on average, from historically low levels a year earlier. That trend, if it continues, accentuates the need for builders to control speculative building during the period ahead and to employ incentives to support sales and limit cancellations. [return to top]

NAHB’s Housing Forecast Still Shows an Orderly ‘Cooling Down’ Process

The housing slowdown obviously is underway, the interest rate structure is moving upward, affordability still is deteriorating and the supply-demand balance has changed quite a bit in the markets for both new and existing homes. Furthermore, evolving adjustments in condo markets appear to be rougher than in single-family markets.

NAHB’s forecast of a soft landing for the housing sector is grounded on a positive forecast for the national economy and the national job market. In this regard, we’re assuming that the Federal Reserve wants to keep the overall economy on a solid growth path while strength shifts from housing to other sectors that finally appear to be coming along nicely — particularly business investment in capital equipment and structures as well the export market. [return to top]

But Risks to Housing Definitely Are Mounting

The kind of sectoral rotation we’re forecasting is tricky business, of course, and housing definitely faces higher risks than earlier in this economic expansion. For one thing, an abnormally large share of national employment growth has been concentrated in housing and housing-related industries, and job losses in these areas may be hard to replace in the other sectors that are expected to take up the slack.

Another nagging concern relates to potential shifts in behavior by those investors/speculators that overheated the single-family and condo markets last year. We’re fully expecting reductions in investor purchases, and we view that as a healthy development. But we’re definitely in uncharted waters when it comes to investor behavior, and large-scale cancellations along with dumping of units owned back onto the markets would be more trouble than we’re anticipating. [return to top]

Want to Know Your State and Metro Forecasts for 2006?

Anticipate the trends, make better decisions and improve your bottom line. HousingEconomics.com, the online publication from NAHB Economics Group, is your single source for market analysis, forecasts, housing statistics and more. In-depth analysis and detailed Excel tables and overviews are available for all the state and metro forecasts.

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Home Builders Forecast ― state, metro, non-residential, remodeling, etc.
Exclusive access to NAHB’s staff of economists
The Seiders' Report
Housing Market Statistics — 29 tables including housing starts, home prices, building permits, home sales, value of new construction, etc.
Housing Activity
In Depth-Analysis

For more details, visit www.housingeconomics.com. [return to top]

Attend the Spring Construction Forecast Conference in April

Plan to attend NAHB's Construction Forecast Conference on April 27 at the National Housing Center in Washington, D.C. The conference brings together the nation's premier housing economists and finance experts for an in-depth examination of the economic outlook for the housing industry.

For more information, visit www.nahb.org/cfc. [return to top]

Give Us Your Perspective on the NAHB Economics Blog

Give your economic perspective on NAHB's economics blog, “Seiders on Housing,” an informal Internet-based forum dealing with economic issues, housing trends, survey research and other topics affecting the housing sector of the economy.

Log onto the blog at http://nahbblog.blogs.com and get direct access to NAHB Chief Economist David Seiders' expert opinions, projections and responses. Then let him know what you think. [return to top]