The Seiders' Report: A Housing Overview by NAHB’s Chief Economist
Highlights
 • The recent upshift in Treasury yields and prime mortgage interest rates poses yet another financing challenge to the struggling housing market —on top of the tightening of mortgage lending standards that’s been provoked by the meltdown of the subprime mortgage market. NAHB’s monthly surveys of single-family builders continue to show serious adverse impacts of tighter lending standards on new home sales and sales cancellations. As a result, many builders have recently marked down their plans for housing starts in the second half of the year.
• Growth of real GDP has been revised downward to an annual rate of 0.6% for the first quarter of this year, the slowest pace in more than four years. But economic growth is firming up nicely in the second quarter and recession remains unlikely during the balance of the of the 2007-2008 forecast horizon (probability=25%). Indeed, we’re expecting near-trend GDP growth during this time frame.
• Residential fixed investment contracted at a 15.4% annual rate in the first quarter and subtracted 0.9 percentage point from the GDP growth rate. This was a major drag on economic growth but not quite as dramatic as during the second half of 2006. We’re projecting a diminishing drag during the balance of this year followed by modest growth of housing production in 2008.
• The U.S. labor market still is performing quite well, despite the abrupt downshift in GDP growth during the early part of 2007, and reported employment in residential construction (builders and specialty trade contractors) continues to hold up incredibly well! The overall unemployment rate held at 4.5% in May, remaining in the low and narrow range that’s prevailed since last fall, and non-farm payroll employment increased by 157 thousand —a highly respectable gain at this stage of the game. Average hourly earnings also continued to rise briskly.
• Core inflation (excluding food and direct energy) has been receding recently, due in part to the slowdown in economic growth since early last year. Indeed, the core price index for Personal Consumption Expenditures dipped to 2.0% (year-on-year) in April, kissing the upper bound of the Federal Reserve’s apparent comfort zone for this key inflation measure. An emerging slowdown in residential rents (and in imputed “owners’ equivalent rent”) should contribute to slowing core inflation down the line.
• The minutes of the May 9 FOMC meeting show preoccupation with potential upward pressures on core inflation among Federal Reserve policymakers, primarily because of persistently tight labor market conditions and rising unit labor costs, and recent statements by Chairman Bernanke and other FOMC members have reinforced those concerns. The Fed almost certainly will hold policy steady at the next FOMC meeting on June 27-28, and NAHB’s forecast no longer anticipates a quarter-point cut at the August 7 meeting. Indeed, the futures market for fed funds now show low projected probabilities of rate cuts at any time during 2007.
• Long-term interest rates have moved up considerably during the past month, despite the good news on core inflation as well as benign inflation expectations in the private sector, and the Treasury yield curve now has a convincing upward slope across its entire range. Long rates have risen as U.S. and global economies have strengthened, as the prospects for easing of monetary policy by the Federal Reserve and foreign central banks have been marked down, and as lengthening of expected durations of mortgage securities have prompted sales of Treasury bonds by portfolio managers.
• The deteriorating supply-demand balance in housing markets has been putting heavier downward pressure on house prices and has been compelling builders to intensify their use of non-price incentives to bolster sales and limit cancellations. Builders generally report at least some success on these fronts, although many prospective buyers obviously are reluctant to go ahead with home purchases in a deteriorating price environment.
• The market value of household real estate and owners’ equity in household real estate grew at modest rates in the first quarter, according to Federal Reserve estimates, although the gains most likely were overstated. Furthermore, there’s a rising tide of vacant housing units on the market, mortgage delinquencies and foreclosures are on the rise, and owners’ equity in real estate is likely to weaken during the balance of the year as house prices continue to adjust. Even so, we’re not expecting serious “spillover” effects from weakening housing equity on consumer spending in 2007 or 2008, a judgment that’s consistent with Federal Reserve expectations.
• Large homebuilders, as a group, are experiencing sharper reductions in gross home sales and higher cancellation rates than the rest of the housing industry, primarily because of their relatively heavy geographic concentration in previously hot markets that now are experiencing relatively sharp reversals. NAHB’s proprietary survey of 30 large companies shows net sales for May (seasonally adjusted) at the lowest level since late 2001 as well as cancellation rates that have moved back toward recent highs.
• Fed Chairman Bernanke delivered two addresses on the subprime mortgage topic during the past month, tracing the development of the crisis and discussing the implications for the housing market and the overall economy. While owning up to a good deal of uncertainty about the depth and duration of subprime-related impacts on housing market activity, the Chairman expressed confidence in fundamental economic factors that “should ultimately support the demand for housing” —without suggesting a time frame for this ultimate outcome.
• Recent NAHB surveys of builders regarding impacts of the subprime phenomenon, along with the unexpected upshift in the interest rate structure, have prompted another trim to NAHB’s housing outlook for the balance of this year and 2008. We now expect total housing starts to flatten out at a 1.37 million annual rate late this year, a level that’s 36% below the quarterly peak early last year. The projected contraction in residential fixed investment now extends through the fourth quarter of the year.
• The 2007 State of the Nation’s Housing report, released by Harvard’s Joint Center for Housing Studies on June 11, pegs the average annual demand for new housing units (including manufactured homes) at 1.95 million for the 2005-2014 period —close to NAHB’s most recent long-term forecast and well above the average for the previous 10-year period. That means we’re looking for a major recovery process beyond the projected trough late this year (1.46 million units), although the climb back to trend figures to be a multi-year march.
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