Housing Economics - 04/16/2010 (Plain Text Version)

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In this issue:
Housing Starts And Permits Rise in March
National Outlook
Housing Market Statistics At-A-Glance

National Outlook

Highlights

The series of blizzards in the eastern part of the country took a substantial toll on seasonally adjusted economic data for February, particularly in the labor market and the housing sector. The negative weather effects presumably are being reversed in March, however, and the economic picture for the first quarter as a whole still looks reasonably bright.
We expect real GDP to grow at a trend-like 2.9% annual rate in the first quarter of this year, roughly half the growth rate recorded in the final quarter of 2009. The projected slowdown reflects the inevitable evolution of the powerful inventory cycle, and we expect growth of real final sales to be similar to the decent fourth-quarter performance (1.9%).
Within real final sales, we're expecting particularly strong first-quarter growth contributions from consumer spending, business spending on capital equipment and software, and spending by the federal government. On the downside, nonresidential construction will continue on the steep downward path that's been evident for more than a year. Spending by beleaguered state and local governments also will continue to slide downward, and net exports should exert a drag on economic growth in the first quarter as growth of imports exceeds growth of exports.
Looking forward, we expect inventory investment to flatten out before long while real final sales gather momentum during the balance of the 2010-2011 short-term forecast period--a pattern that will generate a series of above-trend quarterly GDP growth rates (ranging from 3.3% to 3.8%). Furthermore, we expect the private domestic components of final sales to increasingly carry the load. The trade sector should remain a modest drag on GDP growth for some time and the government sector should soon become a drag as the state and local component remains fundamentally weak and the federal component falters as fiscal stimulus measures wind down on schedule.
A sharp decline in personal consumption expenditures (PCE) was a central feature of the Great Recession, and healthy PCE growth is essential to our forecast of economic recovery and expansion. A stunning plunge in household net worth, along with a substantial increase in the financial obligations ratio for the household sector, were key factors behind the sharp decline in PCE, and reversal of those patterns is essential to healthy PCE growth going forward. Federal Reserve data show increases in household net worth since the first quarter of last year, and financial obligations ratios have been declining as well. But the net worth gains were relatively small in the final quarter of 2009, due largely to negative holding gains on real estate assets, and future patterns will depend heavily on changes in prices of homes and corporate equities. Our forecast assumes significant, if unspectacular, increases in household net worth in 2010-2011, and those gains should keep the personal saving rate below the highs of last year.
Positive signals in labor markets are beginning to appear as a result of the positive growth in real GDP since mid-2009. These include a substantial slowdown in the rate of payroll job loss, an apparent topping-out of the civilian unemployment rate, and some slippage in the most comprehensive measure of underemployment (U-6). Also, initial claims for unemployment insurance benefits have been trending downward since early last year, and are currently not far above the level that typically signals a pickup in employment.
The reassuring labor market data for February occurred despite the series of blizzards in the eastern part of the country, and it's likely that payroll employment will show some increase in March. We're expecting systematic improvements in labor market conditions during the balance of the 2010-2011 period, with accelerating growth in payroll employment and gradual declines in the unemployment rate.
Despite the projected improvements, we expect the level of payroll employment at the end of the 2010-2011 forecast period to be well below the previous peak in 2007, and we expect the unemployment rate to be well above the so-called "natural" rate (around 5%). The remaining degree of slack in labor markets at the end of 2011 squares with the sizeable negative GDP gap that we expect to prevail at that time, and both conditions bode well for economic growth in 2012 and beyond.
The large degree of slack in the labor market and broader economy have held top-line and core inflation, as well as measures of inflation expectations, at historically low levels. We expect inflation at the producer and consumer level, to hold close to recent rates during the balance of 2010 before firming up modestly in 2011 as the economic recovery proceeds.
The statement issued by the Fed at the conclusion of the March 16 FOMC meeting said that economic activity has "strengthened," that the labor market is "stabilizing," that inflation is likely to be "subdued" for some time, and that financial market conditions are "supportive" of economic growth despite contraction of bank lending. In this context, the FOMC maintained the rock-bottom target range for the federal funds rate (0.00 to 0.25%) and committed to "exceptionally" low rates for an "extended" period of time.
We continue to expect a stable federal funds rate until the second quarter of 2011, followed by a measured pace back to a position of monetary neutrality. We also expect the Fed to combine changes in the funds rate with equivalent changes in the rate paid on reserve balances at the Fed. Prior to bona fide tightening of monetary policy, the Fed will continue to restore the spread between the discount rate and the funds rate and will reduce excess reserves in the banking system via use of reverse repos and term deposits.
The March 16 FOMC statement confirmed that the Fed is closing down the special liquidity facilities that it had created during the financial crisis. The statement also confirmed that the Fed will complete its massive planned purchases of housing agency debt and MBS by the end of this month ($1.425 trillion in total). However, the statement left the door open for future purchases, noting that the FOMC will continue to monitor financial developments and will employ its policy tools "as necessary" to promote economic recovery. The FOMC will be monitoring mortgage-Treasury yield spreads and will move back into the agency MBS market if these spreads widen out substantially after the first quarter of this year.
NAHB's forecast assumes a modest (20 basis point) widening of the mortgage-Treasury yield spread after the first quarter of this year. We expect home mortgage rates to move up gradually throughout the balance of the 2010-2011 forecast period, at least for government-related loans (those backed by Fannie, Freddie or Ginnie). We expect the prime conventional fixed-rate mortgage (FRM), currently around 5.0%, to reach 6.35% by late next year while the prime conventional 1-year ARM, currently around 4.25%, reaches 5.75%. These rate increases, per se, will exert some drag on housing demand, although a modest increase in the expected rate of home price appreciation could keep the overall user cost of capital from rising above recent levels. That's our working assumption at this time.
The record breaking housing "bust" is behind us but the housing markets still are struggling to recover, despite a series of homebuyer tax credits, as the excesses of the earlier "boom" continue to weigh on the markets. Those excesses included the collapse of mortgage lending standards and the associated surges of speculative home buying and real house prices. House prices apparently have about corrected, at least in nominal terms, but near-record housing vacancies and extremely large numbers of underwater mortgages still are hanging over the markets. These weights are particularly heavy in the new-home market, where recent readings on home sales, housing starts and homebuilder sentiment have been lackluster at best.
We believe that the new-home market will experience a temporary bounce in coming months as adverse weather effects are reversed and as the homebuyer tax credits stimulate some sales prior to their scheduled expiration. We also believe that the fundamental supply-demand balance in single-family and multifamily markets will be improving as employment rises and personal income growth strengthens, as government-related mortgage markets deliver ample credit to qualifying homebuyers at attractive interest rates, and as government efforts to limit the foreclosure wave bear more fruit. We expect improvements in new-home demand to result in stronger production, despite the scarcity of housing production credit at depository institutions, as builders with access to credit or to internally generated funds gain market share.
Our forecasts for new-home sales and single-family housing starts show solid gains in 2010 and even stronger growth in 2011, although the level of starts at the end of this forecast period is only two-thirds of our estimate of the sustainable long-term trend. We believe the volatile multifamily market bottomed out recently, at a record low, but we expect multifamily starts to be down in 2010 (year-over-year) before staging a recovery in 2011 that gets starts back to roughly half their long-term trend.
Construction of new conventionally build housing units, improvements to existing structures, shipments of manufactured homes, and brokers' commissions on home sales will combine to keep Residential Fixed Investment on a solid growth path during the 2010-2011 forecast period. Even so, RFI will only climb back to early-2007 levels and will account for only 4.2% of GDP at the end of this period--a relatively small share by historical standards.

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