Housing Economics - 03/17/2010 (Plain Text Version)

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In this issue:
Single-Family Starts Hold Firm In February
National Outlook
Housing Market Statistics At-A-Glance

National Outlook

Highlights

Data received during the past month, particularly revised and updated readings on business inventory investment, motivated a modest upward revision to the Commerce Department's "advance" estimate of real GDP for the fourth quarter of 2009. The advance estimate showed annualized growth of 5.7%, with a contribution of 3.4 percentage points from a massive slowdown in the pace of inventory liquidation by the nonfarm business sector. The "second" estimate (released February 26) is 5.9%, with an even larger contribution from the inventory component, 3.9 percentage points.
GDP growth is bound to slow down substantially in the first quarter of this year as the kick from the inventory cycle weakens, and our current estimate stands at a 3.0% annualized pace. However, growth in final sales of domestic product (excluding the inventory component) actually is firming up to some degree in the first quarter, buoyed primarily by consumer spending and business spending on capital equipment and software. Looking forward, we're expecting growth in overall GDP as well as in real final sales to be running at above-trend rates during the balance of the 2010-2011 forecast period, despite progressive weakening and eventual reversal of fiscal stimulus, and we expect residential fixed investment to be an important part of that process.
The Business Cycle Dating Committee at the National Bureau of Economic Research has not yet designated the trough month for the Great Recession that began in December 2007. Estimates of monthly GDP (prepared by Macroeconomic Advisers), along with indexes of leading and coincident economic indicators (prepared by the Conference Board), suggest that the cyclical trough occurred during the third quarter of last year--thanks largely to the monetary-fiscal policy blitz delivered by the Federal Reserve, Congress and the Administration. Designation of a trough month during that period most likely will be made by the NBER before long, even though the job market continued to lose ground through the end of 2009 and despite the current near-record gap between potential and actual levels of GDP.
Labor market conditions apparently are stabilizing, and systematic improvements presumably are not far down the line. The employment report for January showed a net loss of only 20,000 payroll jobs (following a substantial downward benchmark revision), and further increases in the length of the average workweek as well as in temporary employment suggest that businesses soon will be compelled to increase permanent hiring. Furthermore, the unemployment rate receded from 10.0% in December to 9.7% in January, the broadest measure of labor underutilization fell from 17.2% to 16.5% at the same time, and weekly data on initial and continuing claims for unemployment insurance are not far above levels that typically foreshadow a pickup in hiring. Looking forward, our forecast continues to anticipate positive payroll employment growth beginning in the second quarter of this year, and we expect the unemployment rate to slowly wind down during the 2010-2011 forecast period--reaching 8.4% by the end of that period.
The inflation picture in the U.S. economy remains quite subdued, and a bit more disinflation may very well be in store before firming conditions in product and resource markets put floors under key measures of top-line and core inflation measures as well as under longer-term inflation expectations. But inflation recently has been exhibiting some "stickiness" on the downside, considering the huge amount of slack in the economy, and the recent unexpected drop in the unemployment rate (as opposed to an expected increase) signals a tighter labor market than we had been projecting. Furthermore, the minutes from the January 26-27 FOMC meeting reveal modest increases in the FOMC's projections (i.e., goals) for overall and core PCE inflation in 2010, 2011 and 2012. In response to these various developments, we've raised our projections of key inflation rates by several tenths in both 2010 and 2011, and we now show a modest firming up of inflation rates during the latter part of this forecast horizon.
The Federal Reserve surprised financial markets on February 18 by raising the discount rate by 25 basis points, effective the following day, and by shortening the maximum maturity of discount window loans to overnight, effective March 18. The Fed stressed that these were further steps toward "normalization" of the central bank's lending facilities, following the extraordinary expansion of those facilities during the financial market crisis. None of the steps that have been taken toward normalization can be construed as bona fide tightening of monetary policy, although the groundwork for eventual tightening obviously is being laid by the Fed.
The Fed's "exit strategies" are becoming more apparent as time passes. Following restoration of a normal spread between the federal funds rate and the discount rate, a process that's now underway, the Fed most likely will begin to reduce excess reserves in the banking system through use of reverse repos and term deposits--steps that will foreshadow but not actually constitute monetary tightening. These steps eventually will be followed by increases in both the fed funds rate and the rate paid on reserve balances at the Fed; in fact, the Fed may establish a "corridor" for the funds rate between the discount rate and the rate paid on reserves. In the meantime, term securities held on the Fed's balance sheet (including housing agency debt and guaranteed MBS) will be allowed to run off naturally, with outright sales by the Fed much further down the line.
The Fed's upward adjustment to the discount rate on February 19 was done "in light of continued improvement in financial market conditions." Indeed, on February 10, Chairman Bernanke had telegraphed such an adjustment as part of Congressional testimony dealing with the "Federal Reserve's Exit Strategy." This testimony described and rationalized the unwinding of the liquidity, lending and asset-purchase programs that had been put in place by the Fed during the financial market crisis, as the Chairman argued that those extraordinary measures no longer are needed to stabilize the financial system or to improve the functioning of private credit markets. The Chairman also noted that the Fed's asset-purchase programs (housing agency debt and MBS as well as Treasury securities) had flooded the banking system with reserves, giving banks the wherewithal to expand lending to households and businesses. Of course, the banks still are sitting on huge excess reserve positions, and the Fed's most recent (January) Senior Loan Officer Opinion Survey showed maintenance of extremely tight lending standards, to the detriment of small businesses and those lacking access to public debt markets--including most home building companies.
NAHB's forecast continues to anticipate the first upward adjustment to the Federal funds rate (and the rate paid on reserves) in the second quarter of 2011, although the chances for an earlier move have increased to some degree. We have increased the speed of upward adjustment once the Fed embarks on the path back to monetary neutrality--in view of the downward adjustment to the path of the unemployment rate, the upward adjustment to our forecast of PCE inflation, and the upward adjustment to the Fed's 2010-2012 inflation outlook in the minutes to the January 26-27 FOMC meeting.
We've also raised our forecasts of longer-term interest rates to some degree, beginning in the second quarter of this year, on the assumption that the Fed soon will begin to signal expiration of the so-called "EE" phase in FOMC statements – i.e., that economic conditions are likely to warrant "exceptionally low levels of the federal funds rate for an extended period." With respect to the structure of long-term rates, we're expecting the spread between the 10-year Treasury yield and the yield on prime conventional conforming fixed-rate home mortgages to widen only modestly when the Fed's purchases of agency MBS cease at the end of the first quarter of this year.
The projected economic and financial market environment should provide solid support to household formations, home sales and house prices throughout the 2010-2011 period, and the current homebuyer tax credits promise to provide some extra boost to sales of both new and existing homes in the first half of this year (with some payback in the second half). Foreclosure sales, short sales and a heavy overhang of vacant for-sale units in the single-family housing stock will continue to feed into existing-home sales and hold down house prices for some time, maintaining stiff competition for the new-home market, although recent data on mortgage delinquencies and foreclosures (from the MBA) suggest that some of those pressures may begin to subside before long. While the data on demand for new homes in the early part of this year (including NAHB's survey measures) are hardly robust, we're projecting a 24% increase in new-home sales for 2010 as a whole (coming off the lowest year on record), followed by a 53% gain in 2011 that will lift sales volume back toward the 2007 level.
Inventories of new homes that are either under construction or completed have been reduced dramatically during the past two years, and the projected upswing in new-home sales can be expected to generate a similar upswing in single-family housing starts; in fact, we're projecting increases of 25% and 52% for 2010 and 2011, respectively. The supply of credit at depository institutions for land acquisition, land development and construction of single-family homes (AD&C credit) promises to remain quite stringent for some time, and achievement of our single-family starts forecast may very well involve a shift in market share from small builders to large companies with internally generated funds or with access to public debt markets.
Multifamily housing starts have bounced off their record low in the final quarter of 2009, but this sector hardly is poised for meaningful recovery. Near-record rental vacancy rates and persistence of a large overhang of vacant for-sale units in the multifamily housing stock make it perfectly clear that the supply-demand imbalance in this sector is severe, at least at the national level. We expect 2010 to be the low-water mark for multifamily starts (89 thousand units), and a projected 69% gain in 2011 will leave starts at less than half the average level that prevailed during the so-called "Golden Age of Multifamily Production" that ran from 1997 to 2007.
Our forecasts for home sales, single-family and multifamily housing starts, manufactured home shipments, and improvements to the conventionally built housing stock yield a strong growth path for the housing production component of real GDP (Residential Fixed Investment) during the 2010-2011 period. Even so, RFI will remain well below its potential trend level at the end of this period, based on projected demographic trends, replacement needs and second-home demand. Thus, both the overall economy and the housing sector should have plenty of growth room at the end of the short-term forecast horizon.

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