The Economy Is Losing Forward Momentum
The heady 3.3 percent growth in real gross domestic product (GDP) that has been reported by the Commerce Department for the second quarter of the year was a temporary — and somewhat suspicious — bounce.
Some sectors of the economy, particularly consumer spending, have been weakening since mid-year, and overall GDP growth is bound to weaken in the second half of this year.
We still expect positive growth in the third quarter, but we anticipate small negatives in the fourth quarter and in the first quarter of 2009 as well.
NAHB’s economic outlook, if realized, certainly keeps alive the chances for an official recession “call” by the Business Cycle Dating Committee at the National Bureau of Economic Research. We currently estimate the probability of official recession within the 2008-2009 period at roughly 60 percent, although we expect the setback to be mild by historical standards.
The Job Market Provides Clear Evidence of Economic Deterioration
The job market has been weakening systematically since late last year and there’s certainly more to come.
Payroll employment fell by another 84,000 in August, bringing the cumulative loss since last December to 605,000. Furthermore, the unemployment rate jumped by 0.4 percent to 6.1 percent in August, compared with the cyclical low of 4.4 percent reached last March.
We expect payroll employment to continue downward through the first quarter of 2009 at roughly the same average pace that was registered during the first eight months of this year. We also expect the unemployment rate to gravitate upward further, topping out around 6.3 percent by the third quarter of 2009.
These profiles are reasonably consistent with mild recessionary conditions in the U.S. economy.
The Inflation Situation Is Looking Better
The explosion is global oil prices reached record proportions in July, approaching $150 per barrel, but oil prices now have fallen well below $100.
That’s still high by historical standards, of course, but the near-term implications for both top-line and core inflation definitely are positive — despite temporary shocks during the hurricane season.
Growing slack in labor markets inevitably puts downward pressure on labor costs in the business sector, and unit labor cost traditionally has been the key driver of core consumer price inflation in the U.S. economy (excluding direct energy and food prices).
NAHB’s forecast shows a slowdown in both top-line and core inflation over the balance of this year and in 2009, an expectation that’s shared by policymakers at the Federal Reserve.
Carnage on Wall Street Reaches Extraordinary Proportions
The financial markets have endured successive rounds of extraordinary volatility for more than a year.
The trigger was the meltdown of the subprime mortgage market that began early last year, and mortgage credit problems have expanded and multiplied as other components of the mortgage market (including Alt-A and prime) have been drawn in — within an environment of declining house prices.
The result has been massive write-down of portfolios of mortgages and private mortgage-backed securities, decimating capital positions at a number of large, highly-leveraged financial institutions.
The most recent round of turmoil includes the Sept. 7 federal takeover of the secondary-market GSEs Fannie Mae and Freddie Mac, the Sept. 14 bankruptcy of Lehman Brothers and the federally-encouraged purchase of Merrill Lynch by Bank of America, and the Sept. 16 Federal Reserve “rescue” of the American International Group (AIG).
There is naturally rampant speculation about the next major financial institution to fail and about further steps that may have to be taken by the federal government — either in public or behind the scenes.
The Stampede Toward Credit Quality Drives Down Home Mortgage Rates
The silver lining amidst the most recent round of financial market turmoil has been a massive flight to the Treasury securities market and to markets for securities that have strong federal backing, a flight that has driven prices of these investments upward, and their required yields downward.
In the mortgage market, the key beneficiaries have been FHA and VA loans that have the backup of the Ginnie Mae-guaranteed securities program, and prime conventional conforming mortgages saleable to Fannie Mae and Freddie Mac — companies that now have had the explicit backing of the federal government since Sept. 7.
Rates on these types of mortgages have fallen sharply in the past two weeks, and NAHB’s forecast shows a significantly lower profile of mortgage rates through 2009 than we had expected a month ago.
The Fed Holds Monetary Policy Steady — For Now
The Federal Reserve held short-term interest rates steady at the Sept. 16 meeting of the Federal Open Market Committee (FOMC), keeping the federal funds rate at 2.0 percent and the discount rate at 2.25 percent. The unanimous decision disappointed financial markets, in the context of the unprecedented turmoil in domestic and international capital markets.
The Sept. 16 FOMC statement highlighted “strains in financial markets” as well as “tight credit conditions,” but the monetary policy decision came down to a traditional assessment of the downside risks to real economic growth, on the one hand, and the upside risks to inflation, on the other — risks that the FOMC apparently considers to be roughly in balance, at least for now.
As usual, the FOMC statement said that the policy committee “will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.”
We believe that evolving weakness in economic growth, the evolving slowdown in key inflation measures and further tightening of credit market conditions will compel the Fed to ease monetary policy a bit further before the end of the year, and we do not expect the funds rate to move back above 2.0 percent before the middle of next year.
The Housing Market Should Stabilize Before Long
The current housing contraction already is the most serious of the entire post-World War II period and includes the kinds of downward price adjustments not seen since the 1930s.
But there now are a number of indicators suggesting that housing demand is beginning to stabilize. Furthermore, recently enacted federal policies to support home buying and limit foreclosures, along with the recent declines in home mortgage rates, will help to support housing demand going forward.
We expect new-home sales to stabilize in the fourth quarter of this year at a level that’s 63 percent below the record high registered in the third quarter of 2005. We expect single-family housing starts to bottom out in the first quarter of 2009 at a level that’s 70 percent below the early-2006 peak.
The housing production component of GDP, residential fixed investment (RFI), includes not only production of new single-family homes but also multifamily production, manufactured home shipments, improvements to residential structures and commissions on home sales.
RFI will continue to exert a strong drag on GDP growth over the balance of this year. But the drag should diminish by early next year and RFI should convert back into a positive contributor to economic growth by the second quarter of 2009.
That pattern is one of the keys to solid economic recovery beginning in 2009.
The Longer-Term Housing Outlook is Excellent
The trough of this cycle in housing production will be at an extremely low level, compared with our estimate of the longer-term potential for housing production in the U.S.
Thus, once off the bottom, the growth potential for the housing market will be tremendous, and we’re looking for strong expansion during the 2010-to-2012 period as we climb back to sustainable trend levels ¯ around 1.85 million housing starts.
The path back to trend figures to be relatively smooth, and the kind of boom-bust housing cycle we’ve experienced during the past six years certainly is not on the horizon.
That boom-bust pattern is traceable to financial market excesses that provoked a violent snap-back, and we hopefully will not see anything like that for a very long time — if ever.