By David F. Seiders, Chief Economist, National Association of Home Builders
Above-trend GDP growth has generated solid growth in employment and systematic reductions in the unemployment rate since the summer of 2003, despite maintenance of healthy gains in labor productivity (output per hour). Earlier in the expansion, tepid GDP growth combined with an early-cycle surge in productivity left us with a job-losing economic “recovery,” but all that has changed (at least nationally).
The employment report for March was another healthy one, showing a 211,000 increase in payroll employment and a downtick in the unemployment rate to 4.7 percent — the lowest for the expansion to date. That’s certainly good news, but the gradual reduction of slack in the labor market has been putting systematic upward pressure on average hourly earnings, and unit labor costs have been on the rise as growth of labor productivity has slowed from that early-cycle surge.
One of the culprits in this plot is a low and stagnant labor force participation rate (around 66 percent), a factor that contributes to labor market tightness as the economy expands.
Core Inflation Still Under Control
Dramatic shifts in energy prices have been pushing headline inflation numbers all over the place, but it is “core” inflation (excluding food and energy prices) that really matters when the future of the economic expansion is at stake. Our central bank is preoccupied with core inflation, and it appears that the Fed has established “tolerance ranges” to guide the management of monetary policy.
The core Producer Price Index (PPI) is down the list in order of importance, since the Fed is not preoccupied with inflation at this level, but it’s hardly irrelevant to the inflation process. The core PPI for finished goods was up by only 1.7 percent on a year-over-year basis in March, the same as in February and well below rates recorded during most of last year.
Core inflation at earlier stages of production (intermediate and crude goods) is running a good bit higher, but that’s a long distance from the inflation rates the Fed worries about.
The core Consumer Price Index (CPI) is more prominent on the Fed’s radar screen, and it appears that the Fed’s tolerance range for the core CPI is between 1.5 percent and 2.5 percent (year-over-year basis). This measure showed a 2.1 percent gain in March, the same as in January and February and still well within the Fed’s range.
However, the technically superior chain-core CPI (allowing for substitution among goods and services in the market basket) showed a year-over-year gain of 2 percent, up from 1.8 percent in the previous three months. The upper end of the Fed’s tolerance range for the chain-core CPI presumably is around 2.2 percent, so we’re getting pretty close on that front.
Fed Near End of Rate-Hike Process
The Federal Reserve has hiked the federal funds rate by 25 basis points at each of the 15 Federal Open Market Committee (FOMC) meetings held since mid-2004, and the funds rate now stands at 4.75 percent. The Fed’s expressed objective has been to remove the massive monetary policy “accommodation” poured into the economy between mid-2003 and mid-2004 and get policy back to “neutral” before the economy generates serious inflation pressures.
The public statement issued at the conclusion of the last FOMC meeting (March 28) hinted at an additional quarter-point rate hike at the next policy meeting on May 10, and financial markets have been speculating about even more tightening down the line. But the minutes from the March 28 meeting (released yesterday) suggested that some FOMC members are not actually preoccupied with inflation dangers. Some expressed concerns that monetary tightening could go too far, particularly in view of well-documented lagged effects of monetary tightening on the economy.
We’ve been assuming just one more Fed tightening move (on May 10), and the FOMC minutes reinforce our judgment on that point.
Housing Market Indicates ‘Cooling Down’
NAHB’s single-family Housing Market Index (HMI) showed another decline in April, falling to the lowest level since a temporary plunge in the wake of the terrorist attacks on Sept. 11. The HMI now is at 50, the balance point between positive and negative builder perspectives regarding the demand for single-family homes.
The index of applications for mortgages to buy homes (Mortgage Bankers Association series) also continues to illustrate the downshift in demand. In the second week of April, this measure was down by 17 percent from the cyclical peak at mid-2005 (four-week moving average basis), despite a modest rise since mid-March, as committed buyers apparently moved to lock in mortgage rates in a rising rate environment.
Housing starts were quite strong in the January-February period, despite an obvious downtrend in housing demand as well as NAHB builder surveys that illustrated builder recognition of that downtrend. But total starts were down by nearly 8 percent in March and the single-family component retreated by 12 percent.
Even so, the first-quarter averages for total, single-family and multi-family starts all hit cyclical highs. Positive weather effects appear to be largely responsible for that conundrum, weakening demand but strengthening supply.
Soft Landing for Housing Still Best Bet
Unsold inventories of new homes definitely are elevated at this time. Many builders are reporting an upshift in cancellations of sales contracts signed earlier, and many companies, particularly larger ones, are telling us that investors/speculators are not only cancelling sales contracts but also reselling homes they had closed on earlier. It’s obvious that home purchases by investors/speculators are well down from this time last year.
In view of these evolving developments, we’re still projecting downward adjustments to home sales, and housing starts over the balance of this year and in 2007.
The anticipated degree of decline in starts for 2006 (6 percent to 7 percent) still qualifies as a “soft landing” for the housing market, following non-sustainable exuberance in 2005. We expect much of the decline to reflect withdrawal of investors/speculators from housing markets as the change in supply-demand balance takes a toll on price appreciation and price expectations in single-family and condo markets.