Economic Bounce-Back in Progress

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By David F. Seiders, Chief Economist, National Association of Home Builders

Economic growth faltered, bounce-back in process
Growth of real gross domestic product (GDP) slowed even more than expected in the final quarter of 2005, slipping to an annual rate of only 1.1 percent, according to the “advance” estimate released by the Commerce Department Jan. 27. This was the lowest growth rate in three years and raised serious questions about the sustainability of the economic expansion.

Data since the release of the anemic GDP report suggest only a slight upward revision to the fourth-quarter “advance” estimate. However, the composition of the slowdown, along with available indicators of economic activity for the early part of 2006 and an obvious swing in weather conditions, point toward a nice rebound of GDP growth in the first quarter of this year. Although the quarterly patterns have changed quite a bit, we’re still forecasting above-trend GDP growth for 2006.

Labor market performing well, slack shrinking
Payroll employment growth was solid in January (a net gain of 193,000 jobs). This performance, along with upward revisions to fourth-quarter payroll jobs and a downward trend in claims for unemployment insurance through January, provide reassuring evidence that forward momentum in the economy has been well maintained despite the fourth-quarter GDP shortfall. Furthermore, the nation’s unemployment rate moved down significantly to 4.7 percent in January, the lowest level of the economic expansion to date.

A falling unemployment rate certainly is good news for the country, although sluggish growth in the labor force and a disappointingly low labor force participation rate (66 percent) are parts of the pattern. In any case, it’s clear that the degree of slack in labor markets is being systematically reduced, with potential inflationary consequences as the economic expansion rolls along.

Core consumer price inflation remains low
Alternative measures of labor costs are throwing off somewhat different signals, but movements in average hourly earnings in the employment reports show a definite pattern of acceleration in recent months. This pattern, combined with an apparent cyclical slowdown in growth of labor productivity, has heightened concerns about rising unit labor costs down the line. The Federal Reserve, of course, views unit labor costs as the key to core inflation patterns.

Measures of core consumer price inflation, including the market-based core personal consumption expenditures (PCE) price index –the Fed’s favorite – remained very much under control through the end of 2005. But broader measures of core inflation, including the core GDP price index, have accelerated to some degree.

Some pass-through of high energy costs into core inflation is likely, and unit labor costs are likely to firm up to some degree before long. We’re projecting some increase in core inflation this year, threatening the bounds of the Fed’s implicit comfort zone.

Fed hiked short-term rates, another increase in cards
As expected, the Fed enacted another quarter-point increase in short-term interest rates at the Jan. 31 meeting of the Federal Open Market Committee (FOMC), raising the federal funds rate target to 4.5 percent. The FOMC statement was less committal than prior statements about future rate hikes and also dropped the word “measured” in describing the possible degree of future tightening.

In essence, these changes give the new Fed chairman, Ben Bernanke, maximum flexibility to craft future monetary policy. That’s a present from Alan Greenspan, who chaired his last FOMC meeting on Jan. 31.

The Jan. 31 FOMC statement not only insisted that the economic expansion remains “solid” despite recent “uneven” economic data (including the fourth-quarter GDP report), but also it fretted about the inflation potential of tightening resource markets and elevated energy prices.

The rather hawkish tone of the statement, along with recent signals from both labor and energy markets, have compelled us to add another quarter-point rate hike to our forecast of the funds rate, to occur at the next FOMC meeting on March 28.

Homeownership rates, multi-family rental vacancies down
Soaring costs of home buying combined with sluggish growth in apartment rentals have led to erosion of the nation’s homeownership rate and a simultaneous reduction in the multi-family vacancy rates, both from record highs posted in the early part of 2004. Indeed, the vacancy rate for apartments in buildings with five or more units has fallen from 12 percent to 9.5 percent in the process, retreating to a level not seen since early-2001.

While multi-family rental vacancy rates have been tumbling, the rental vacancy rate for single-family homes has been climbing to higher and higher levels.

For the first time in recorded history, the single-family rate climbed above 10 percent and actually exceeded the multi-family rate in the final quarter of 2005. The strength of this movement is symptomatic of the dramatic upswing in the investor share of home purchases since the late-1990s.

The National Association of Home Builders is a Washington, D.C.-based trade association whose mission is to enhance the climate for housing and the building industry. Chief among nahb’s goals is providing and expanding opportunities for all consumers to have safe, decent and affordable housing.

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