The economy is laboring through the “soft patch” . . .
Federal Reserve Chairman Alan Greenspan recently told Congress (and the world) that the U.S. economy hit a “soft patch” around the end of the third quarter, largely because of impacts of “heightened geopolitical risks” on the behavior of businesses and consumers. He also said that the Fed’s dramatic half-point cut in short-term interest rates on Nov. 6 was “cheap insurance” against the small risk of a significant decline in the economy.

Incoming data clearly show that the “soft patch” has materialized, and that a fourth-quarter downshift in economic growth is inevitable; indeed, we’re forecasting 1.1% GDP growth following 4% in the third quarter. But it also seems likely that economic growth will begin to pick up early next year, paving the way for a stronger recovery process that will soak up slack in the labor markets during 2003 and 2004.

The Fed’s aggressive monetary policy stance certainly will help get the economy back in gear, as will strength in government spending; and the recent (net) improvements in the stock market can’t hurt the attitudes of consumers and businesses. NAHB’s forecasts show GDP growth in the 3.5% - 4% zone by the second quarter of 2003, and that’s enough to start moving the unemployment rate off its cyclical highs. The situation in Iraq still poses substantial risk to the economic outlook, but the growing presence of U.N. weapons inspectors apparently has calmed financial markets even though the Bush administration has remained outwardly skeptical about the whole process.

The Fed won’t resort to extraordinary measures . . .
The Fed’s rate cut on Nov. 6 took the federal funds rate to a 41-year low (1.25%) and pushed the “real” funds rate into negative territory despite very low rates of inflation. This sequence of events has prompted concerns that the Fed is running out of monetary ammunition at a time when destructive price deflation is lurking just beyond the horizon. The plight of the Japanese economy and the Bank of Japan has fueled these concerns; indeed, Japan has been drifting in and out of recession for more than a decade while price deflation has been deepening and not even a zero overnight interest rate can stem the tide.

Those who see the U.S. going the way of Japan argue that the Federal Reserve should resort to extraordinary measures sooner rather than later. Many would have the Fed focus on reducing long-term interest rates by buying Treasury bonds in its open-market operations, a strategy that was used occasionally in the past with only modest success. But the Fed has made it clear that deflation in the U.S. is not really a serious threat at this time and that the economy is likely to emerge from the current “soft patch” before long. Thus, don’t look for extraordinary measures from the Fed; indeed, look for stable policy at the next FOMC meeting on Dec. 10 as well as at the meetings early next year. The next change in monetary policy is likely to be toward higher rather than lower rates, and we currently expect the Fed to start moving the funds rate back toward neutral around mid-2003. [return to top]

Single-family housing continues to shine . . .
The housing sector continues to shine brightly in the midst of a murky U.S. economic picture. The housing production component of GDP (residential fixed investment) made another positive contribution to economic growth in the third quarter, despite modest slippage in the multifamily sector. Furthermore, recent data point toward ongoing gains in the single-family market, partly at the expense of the rental market.

Single-family construction put-in-place rose at an annual rate of 5.2% in October, and total home sales for the month (new and existing combined) surged to a near-record annual rate of 6.8 million units. NAHB’s Housing Market Index (based on monthly surveys of single-family builders) climbed to 65 in November, the highest level in two years, and weekly surveys of lenders conducted by the Mortgage Bankers Association continued to show near-record applications for mortgages to buy homes as November drew to a close. Strong forward momentum in the monthly and weekly indictors virtually guarantees strong support to the U.S. economy from the single-family housing market in the final quarter of 2002, and that support will be quite important to maintenance of positive GDP growth within Greenspan’s “soft patch.” [return to top]

House price increases are decelerating but not falling . . .
Despite rampant speculation in the media about “bubbles” in house values, home prices continue to move up at a healthy pace in most places. Nationally, house prices were up by 6.2% in the third quarter, compared to the same period last year (OFHEO House Price Index). This performance extended a pattern of gradual deceleration from the peak rate of increase (about 9%) recorded in early 2001 just prior to onset of the national recession. Growth in “real” (inflation-adjusted) house values has been decelerating as well, but substantial gains still are accumulating in an environment of very low rates of general price inflation.

House prices have been decelerating in most parts of the country, but outright declines still are hard to find on an annual basis. In the third quarter, prices were up from a year earlier in all nine Census Divisions (ranging from 9.8% in New England to 3.1% in the East South Central area) and in all 50 states (ranging from 14.1% in Rhode Island to 2.1% in Utah). That means that real price gains were registered in all major regions and virtually all states. Indeed, all but 10 of 185 major metro areas had annual price gains of more than 2% in the third quarter and only one area (San Jose, CA) was in the red zone (-0.4%)

It’s becoming increasingly clear that the prophets of house-price doom are simply wrong. It’s likely that rates of house price appreciation will continue to decelerate somewhat further, moving into the 4% - 5% range on a national basis, but widespread declines in real house values are extremely unlikely. Furthermore, widespread declines in nominal house values are out of the question in an environment of strengthening economic growth and only modest upward pressure on interest rates (the best bets for 2003 and 2004). [return to top]

Corporate sector still governs shape of economic expansion . . .
The recession of 2001 was concentrated in the nonresidential business sector, and profound weakness in corporate profits along with the protracted decline in the stock market have forced corporate America into a frenetic process of cost cutting that has held back hiring as well as spending on inventories, capital equipment and nonresidential structures. Unwinding of the excesses of the late 1990s and the construction of foundations for the next expansion obviously are taking some time!

But the process is moving along. Profit reports now are mixed rather than overwhelmingly negative. Inventory/sales ratios are back in reasonably comfortable zones. Spending on equipment and software has perked up to some degree after six quarters of contraction. Spending on nonresidential structures is still trending downward, although there were some glimmers of hope in the October construction data.

Decent recoveries in corporate profits and the stock market, along with growth in business spending on labor, inventories, capital equipment and structures, are central features of our projected economic expansion for 2003 - 2004. In this environment, the housing markets should be operating at high levels but not serving as a major growth engine for the economy (that’s just fine). [return to top]

Find more in-depth information in our economics publications . . .
Want more in-depth information? Subscribe to our three economics publications, Home Builders Forecast, Housing Market Statistics, and Housing Economics.

• Home Builders Forecast includes analysis of single-family and multifamily residential activities, residential remodeling, and the full range of nonresidential construction, as well as the macroeconomic factors such as GDP, employment, and interest rates that drive construction. If your business depends on reliable estimates of housing starts, construction spending, and remodeling activity, Home Builders Forecast is designed to meet your needs.
• Housing Market Statistics contains an overview of important developments and trends that serves as an executive summary of the current industry situation. It also contains annotated charts depicting movements in key indicators and tables providing monthly, quarterly, and annual data for more than 250 variables.
• Housing Economics is our monthly rigorous overview of the economy, data for more than 100 local markets, and in-depth analyses of the niches and nuances of home building markets. Available online or in print, it is written in terms that builders, manufacturers, and housing finance professionals can understand and apply to their own businesses.

To learn more or to order any of these three NAHB economic publications, visit the Economics Publications Information section of the NAHB Web site or call 800-223-2665. [return to top]