By David F. Seiders, Chief Economist, National Association of Home Builders
Growth of real Gross Domestic Product (GDP) slipped to an annual rate of 2.6 percent in the second quarter of 2006, according to the “final” estimate released by the Commerce Department on Sept. 28. This definitely was a below-trend pace with sobering implications for the labor market.
The housing production component of the economy, Residential Fixed Investment (RFI), was the weakest element of the second-quarter GDP report. Indeed, RFI contracted at an annual rate of 11.1 percent and subtracted 0.72 of a percentage point from the overall GDP growth rate — a massive swing from the 1.11 positive contribution delivered a year earlier.
The downswing in housing production is also taking a toll on some forms of consumer spending, including the “furniture and household equipment” component of personal consumption expenditures.
Third-quarter GDP growth will be even weaker than the second-quarter performance (we’re currently estimating 2 percent), largely reflecting a further downswing in RFI and associated impacts on consumer spending.
However, we’re projecting somewhat better GDP growth in the final quarter of this year and in 2007, as the housing downswing becomes less severe and other sectors of the economy gain more strength.
Core inflation still troublesome despite slowdown
The evolving slowdown in growth of economic output (real GDP) and payroll employment is bound to relieve upward pressures on unit labor costs and core inflation, and the recent retreat of energy costs inevitably will limit the “leakage” of these costs into the core inflation numbers. Having said that, there definitely are time lags in those relationships, and key measures of core inflation still were elevated in August.
The core Consumer Price Index (CPI) posted on annualized advance of 2.9 percent in August and a year-over-year gain of 2.8 percent: well above the upper end of the Federal Reserve’s implicit comfort zone for the core CPI (2.5 percent).
Of even more importance, the core price index for Personal Consumption Expenditures (PCE) posted a 2.8 percent annualized gain in August and a year-over-year advance of 2.5 percent: well above the upper end of the acceptable range from the Fed’s point of view (about 2 percent).
The imputed “owners’ equivalent rent of primary residence” once again put perverse upward pressures on both the core CPI and the core PCE price index in August, as home buying continued to weaken and market rents firmed up further. But the core inflation numbers still were somewhat elevated, even after adjustment for this perverse upward pressure.
Long-term interest rates receding despite core inflation readings
Both the Federal Reserve and financial market participants have been able to stomach the recently elevated core inflation rates, relying on the evolving economic slowdown and retreating energy prices to relieve upward pressures on core inflation down the line. Indeed, measures of longer term inflation expectations have been well anchored in recent months despite the elevated inflation readings.
The statement released by the Fed at the conclusion of the Sept. 20 meeting of the Federal Open Market Committee (FOMC) noted the “elevated” readings on core inflation, but argued that “inflation pressures seem likely to moderate over time.”
That judgment allowed the FOMC to hold monetary policy steady for the second consecutive meeting, and it’s highly likely that the Fed will maintain the current target for the federal funds rate (5.25) for the balance of this year and into 2007.
The economic slowdown, benign inflation expectations and the prospects for stable (or even easier) monetary policy have combined to produce an impressive bond market rally. Long-term bond and mortgage rates have come down substantially since mid-year, and those rates should remain close to current levels for some time.
Housing demand may stabilize following downshift
The recent declines in interest rates and energy costs certainly are positives for housing demand, and home sellers now are offering a variety of price and non-price incentives to bolster sales and limit cancellations.
On the other hand, the slowdown in job growth is a negative for demand, measures of housing affordability still are running low and the lure of price appreciation is no longer driving demand by investors/speculators in single-family and condo markets.
Data on home sales for August contained some hopeful signals on the demand side of the markets, although it’s still too early to call an end to the down slide. The preliminary estimate of new home sales for August (contract signings) was up by 4.1 percent from July. However, the data were revised downward for the May through July period, the trend in sales still appears to be downward and sales cancellations are not captured by this data system.
Sales of existing homes (closings) were down only slightly in August, with condos off by 3.5 percent and sales of single-family homes dead flat. “Pending” sales (contract signings) of existing single-family homes bounced back by 4.3 percent in August following an abrupt decline in July.
Price cutting by sellers of existing homes apparently is helping to stabilize sales activity following more than a year of decline, although one month of preliminary data hardly makes a trend.
Sobering signs regarding the condition of housing demand in September are provided by surveys of single-family builders and home mortgage lenders. The NAHB/Wells Fargo Housing Market Index slipped to a level of 30 in early-September, the lowest reading since February 1991 (within the 1990 through 1991 economic recession). The index of applications for mortgages to buy homes (Mortgage Bankers Association series) was up by 3.3 percent in September, but still was down by 20 percent on a year-over-year basis.
Moreover, it’s entirely possible that the September bounce was a temporary event provoked by the unexpected decline in mortgage rates.