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Growing fear over the possibility of a government debt default in
Greece, and similar concerns about Portugal, Spain, Ireland and Italy,
has shocked financial markets, spawned the "European Sovereign Debt
Crisis" (ESDC), and moved the European Union, the European Central Bank
and the International Monetary Fund to piece together a massive
assistance package, valued at over a trillion euros. The U.S. Federal
Reserve has also reopened currency swap lines with the ECB and other
foreign central banks to ensure dollar financing in the
Eurozone--limiting upward pressure on LIBOR rates.
Despite this action, the ESDC has weakened the global economy and
financial system, and "contagion" risks extend as far as Eurozone
sovereign debt holdings. The crisis renews concern about countries with
persistently large and growing structural fiscal imbalances--including
the U.K. and the U.S. NAHB's forecasts have been adjusted to reflect
current conditions, and will be adjusted as the fallout from the crisis
continues. At this point, positive and negative aspects of the crisis
are expected to largely offset, having only a small negative impact on
the U.S. economy and its housing sector, at least in the short term.
A strong export performance is going to be needed during the forecast
period to offset the negative impacts on our trade balance of
strengthening U.S. imports. Fortunately, the global economy is
strengthening considerably, led by major "emerging" nations (China,
India and Brazil). Canada also figures to do well, although the outlook
for growth in the Euro zone and Japan is weaker than for the U.S.
Everything considered, including some modest depreciation of the dollar
(trade weighted) and some modest appreciation of the (managed) Chinese
renminbi, we expect the trade sector to exert a slight drag on GDP
growth in both 2010 and 2011.
The negative impacts of the ESDC consist principally of damage to the
global stock market, affecting household wealth and the cost of
corporate equity capital, and damage to U.S. net exports from a falling
euro and weaker economic growth in the Eurozone. On the positive side, a
stronger dollar means less inflation in the U.S., and a weaker global
economy means lower oil prices. Furthermore, fears about credit quality
in the Eurozone have prompted a flight to quality, pushing down rates on
Treasury bonds, U.S. agency securities, and debt and MBS issued or
guaranteed by the US government.
While the ESDC will likely have a small net negative impact on the U.S.
economy, the crisis hit while the economy was doing better than expected
in our forecast last month, particularly in the labor market. This
month's forecast shows slightly slower growth of real GDP and a slightly
higher unemployment rate, lower inflation and lower interest rates. We
expect no meaningful changes in U.S. monetary or fiscal policies in
response to the ESDC, aside from the Fed's recent reinstatement of
currency swap lines.
Real GDP grew at an annualized rate of 3.2% in the first quarter of this
year, according to the "advance" estimate released by the Commerce
Department on April 30. This was a major slowdown from the substantially
above-trend 5.6% pace in the final quarter of 2009, due primarily to a
much smaller kick from the evolving inventory cycle. Growth of real
final sales (excluding the inventory component) edged down from 1.7 to
1.6%, while growth of final sales to domestic purchasers (excluding
exports) strengthened from 1.4 to 2.2%. Within domestic final sales,
strong performances were turned in by consumer spending, business
spending on equipment and software, and spending by the federal
government. Large negatives showed up in spending on both residential
and nonresidential structures as well as in spending by beleaguered
state and local governments.
We're expecting 3.3% growth in both GDP and final sales in the second
quarter of this year and a 3.6% GDP gain in 2011 on a Q4/Q4 basis.
Spending on nonresidential structures will continue to deteriorate, but
residential fixed investment (RFI) will post a strong turnaround based
on improving housing starts. Government spending (federal plus state
& local) will turn positive after two quarters of contraction.
Private final sales increasingly will carry the load as inventories
shift into neutral and fiscal stimulus winds down.
Productivity growth kept the rebound in GDP in the second half of 2009
from generating improvements in the labor market, although the rate of
deterioration slowed. The early months of this year have shown
improvement as employment turned positive and accelerated in March and
April. Private payrolls rose by 231 thousand in April, adding federal
census workers increased the overall employment gain to 290 thousand.
The unemployment rate moved up from 9.7 to 9.9% in April, while the
broadest measure of underemployment (U-6) moved up from 16.9 to 17.1%.
But these are positive signals, reflecting the return of previously
discouraged workers to the labor force.
The pace of GDP growth in our forecast implies ongoing improvements in
the labor market, hiring based on recent growth in corporate profits,
but despite the absence of declines in claims for unemployment
insurance. The second quarter bump from the hiring of temporary census
workers will soften in the third quarter, but this episode should be
followed by consistent job growth over the balance of 2010-2011. The
unemployment rate will trend down reaching 8.4% by late next year. That
will provide room for strong growth with low inflation in 2012 and
The inflation picture remains benign with further declines
expected--aided and abetted by the effects of the ESDC on foreign
growth, oil prices and the dollar. Recent readings on the CPI, the PCE
price index, unit labor costs and longer-term inflation expectations
show that upward pressures on top-line and core consumer price inflation
are negligible at this time. We expect these inflation measures to
remain historically low during the balance of the 2010-2011. Indeed, the
threat of outright deflation has ticked up due to the ESDC, creating an
unpleasant possibility for policymakers at the Federal Reserve.
The Federal Reserve held monetary policy steady at the April 27-28 FOMC
meeting, retaining the rock-bottom target range for the federal funds
rate (0.00 to 0.25%) as well as the increasingly controversial "EE"
language--i.e., that economic conditions are likely to warrant
Exceptionally low levels of the funds rate for an Extended period. The
FOMC statement excluded references to the massive purchase programs for
housing agency debt and MBS (discontinued at the end of March) and noted
that all but one of the special liquidity facilities established during
the 2008-2009 financial crisis had been closed. There was no indication
of plans to "neutralize" the massive volume of excess reserves in the
banking system (via reverse repos or term deposits) or to sell the huge
volume of assets (largely housing agency debt and MBS) held on the Fed's
balance sheet. All in all, the April FOMC meeting held fast to the
The ESDC presents a new challenge to the Fed, particularly if financial
contagion continues to batter the stock market, boost the dollar and
substantially worsen the nonprime credit crunch in securities markets
and at depository institutions. At this point, we assume that the Fed
will not feel the need to resurrect unconventional policies and we
continue to believe that the rock-bottom federal funds rate will be
maintained until the second quarter of next year. Heightened
uncertainties could encourage the Fed to delay the first upward
adjustments even longer, of course, and the Fed could make these
intentions clear to the markets. Such a strategy would put downward
pressure on longer-term Treasury yields, helping to offset the impact of
widening private credit-quality spreads as well as the downward
pressure on equity prices and the upward pressure on the dollar. Stay
The primary home mortgage market currently is grounded on
government-related secondary markets provided by Fannie Mae, Freddie Mac
and Ginnie Mae while private MBS markets are essentially dormant and
depository institutions remain reluctant to add nonconforming whole
loans to their portfolios--to the detriment of the jumbo and nonprime
mortgage markets where yield spreads are quite largeremain above
historic levels. We expect this financing situation to prevail during
the balance of the 2010-2011 forecast period as the secondary market
agencies escape the reach of the financial reform efforts on Capitol
Hill. With respect to credit for housing production, conditions are
bound to remain tight at depository institutions during the forecast
period--consistent with signals from the Fed's April Senior Loan Officer
Opinion Survey on Bank Lending Practices. This credit situation will
favor larger builders with sizeable internal cash flows or with access
to public debt markets.
A heavy overhang of vacant housing units still weights on the housing
market, despite an impressive reduction of new-home inventory from the
highs of 2006. Both the homeowner and rental vacancy rates edged down in
the first quarter of this year but remained close to record highs.
Similarly, the number of vacant year-round housing units both for-sale
and for-rent declined slightly in the first quarter but remain at
historically high levels. We expect this supply situation to limit, but
not prevent, growth of new production and home prices as demand
strengthens during the low-inflation/low-interest-rate economic
expansion that lies ahead.
The demand for homeowner units (single-family homes and multifamily
condos) has been pushed and pulled during the past year by a series of
temporary tax credits for homebuyers, and the final version (expiring
April 30 for contract signings and June 30 for closings) is having
discernable effects on sales volume. Sales of both new (contracts) and
existing (closings) single-family homes climbed by 27% and 7%,
respectively, in March, following slippage in the January-February
period that kept first-quarter sales below the final quarter of 2009.
NAHB's proprietary survey of large single-family builders showed solid
increases in both gross and net home sales in April (seasonally
adjusted), getting the second quarter off to a good start. Furthermore,
NAHB's Housing Market Index rose in both April and May as builders'
views of buyer traffic, current sales and future sales perked up to some
degree. Our forecast incorporates a modest post-credit "payback" in the
third quarter, followed by systematic growth of new-home sales during
the balance of the 2010-2011 period.
Both single-family and multifamily housing starts moved up in the first
quarter, but lagged effects of earlier declines and the pronounced slump
in home sales moved RFI into the negative zone (down at a 10.9% rate).
Single-family starts moved up by 10.2% in April but issuance of
single-family permits fell at a similar rate, pointing to a modest (35
thousand) gain in starts for the quarter as a whole. Multifamily starts
fell back in April, retracing an upward bounce in March, and we expect
the second quarter to remain in the depressed range evident since
mid-2009. Going forward, we expect single-family starts to gain decent
forward momentum during the balance of the 2010-2011 period, although
meaningful recovery of the multifamily market will not begin until late
this year. We're projecting total starts for 1.17 million units by the
final quarter of next year, well below the 1.85 million that we consider
to be the sustainable trend level--based on demographic trends,
replacement needs and the second home market.
The future position of RFI in the GDP accounts will depend not only on
home sales (via brokers' commissions) and the number of housing units
started, but also on the size of conventionally built units, shipments
of manufactured homes, and improvements to the housing stock. We expect
residential remodeling and manufactured homes to be positive growth
factors during the balance of the 2010-2011 period, but the average size
of conventionally built new units is not likely to get back to the
heights of 2006-2007 for some time. By the final quarter of next year,
we expect real RFI to be up by about 65% from the trough in the second
quarter of 2009 and to account for 4.0% of real GDP--still low by
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