National Outlook

Highlights

• 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 beyond.

• 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 status quo.

• 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 tuned!

• 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 historical standards.

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