US Economic Cooling Trend Predicted for September

Location: McLean
Author: Eileen Fitzpatrick
Date: Monday, September 11, 2006
 

The outlook for economic growth and housing activity sounds similar to the seasonal variation in climate: A cooling trend for the balance of this year, with occasional frost, and warmer conditions as we move into next spring.  Real GDP grew at a 4.2 percent annualized clip over the first two quarters of this year, but is poised to grow at less than 3 percent for the remainder of this year, with a rebound in growth in 2007.  Housing activity has slowed appreciably and will likely experience weaker construction and sales volumes through winter before leveling off.

The housing sector had been a robust propellant for economic growth for much of the last few years.  Between the fourth quarter of 2001 and the last quarter of 2005, real residential fixed investment (RFI) grew at an 8.4 percent annualized rate, compared with the 3.0 percent rate for real GDP.  Employment related to construction, home selling, and mortgage lending accounted for approximately 2 of 5 jobs created, on net, over that four-year span.  Economic growth over the next year will be largely sustained by growth in business investment spending and consumer spending – the latter still benefiting from the sizable home equity wealth created during this expansion.

In contrast, the drop in housing starts and home sales has pulled real RFI lower in each of the past two quarters, so that RFI is down 5.2 percent (annualized) over the first half of 2006.  Home-value appreciation has also fallen from the 15.4 percent annual rate of the second quarter of 2005 to the modest 4.9 percent rate of this year’s second quarter, according to our Conventional Mortgage Home Price Index.  Adjusting for inflation, the record real gain of 10 percent over 2005 has been replaced with a real decline (albeit a small one) during the April-to-June quarter of 2006, as the Consumer Price Index (less shelter) was up at a 5.0 percent annual rate, just slightly more than average home values had risen.  Moreover, some regions saw sizeable declines in real home values during the quarter.

Even with the slowing in housing activity, the U.S. is in store to have the third best year on record for the housing industry, surpassed only by 2004 and 2005.  Nominal home values, on average, continue to rise in most markets, adding to home equity wealth and supporting consumer spending, though less than in the past.  Cash-out refinancing remains brisk with the recent dip in fixed-rate mortgage rates; 30-year rates have declined from 6.80 percent for the week ending July 20 to 6.47 percent as of September 7.  About 8 out of 9 refinance loans this year include a cash-out component, which helps to sustain debt consolidation, home-improvement investment, and consumer spending.

Lower fixed interest rates (relative to introductory adjustable mortgage rates) and heightened regulatory scrutiny of interest-only and negative-amortizing products will turn more loan applicants toward fixed-rate product.  The ARM share of purchase-money loan closings has already dipped from 31 percent in January to 24 percent in July, and is likely to move lower.  Refinance volume will remain brisk in the early autumn months with the decline in fixed interest rates, but should decline as we move into 2007.  Lower home sales and refinance activity should reveal a frosty mortgage market in the last quarter of 2006, with originations at their lowest volume in four-and-a-half years; adjusting for inflation, originations will likely be the lowest in six years.  But a spring thaw is expected, as the housing market lands softly on more normal patterns supported by employment and income gains.


 
  • Real GDP growth.  The latest Commerce Department estimates revised second quarter real GDP growth up to a 2.9 percent annual rate, well below the outsized 5.6 percent surge in the first quarter. A sharp deceleration in interest-sensitive sectors—durable goods consumption (rising 0.5 percent) and residential investment (declining 10 percent)—remains the main factor in the slowdown.  Real GDP growth is expected to stay near 3.0 percent through the first half of 2007.
  • Consumer price inflation. Energy prices continued to boost headline inflation in July, with the Consumer Price Index up 0.4 percent. Core inflation—CPI less food and energy—was more restrained, rising 0.2 percent, the smallest gain since February. We continue to expect that a slowing of economic growth in the second half of the year and a leveling off of energy prices will dampen inflation over the medium term.
  • Unemployment rate. The unemployment rate edged down to 4.7 percent in August as nonfarm payrolls rose 128,000, in line with job gains in recent months. There was little evidence of labor market tightness causing wage pressures, however, as average hourly earnings were up a scant 0.1 percent, and we expect wage pressures to remain contained as economic growth cools.
  • Mortgage rates. With recent data suggesting economic growth is moderating and inflationary pressures in check, and monetary policy unchanged at the August Fed Open Market Committee meeting, rates on 30-year mortgages have moved down nearly 40 basis points from their mid-summer peak and are expected to average 6.5 percent in the second half, fluctuating as high as 7 percent as volatility in the bond market remains.
  • ARM share. The ARM share of conventional mortgages is expected to move down further from 25 percent in the second quarter to 21 percent by the end of the year as higher short-term interest rates reduce the attractiveness of ARMs and homebuyers seek to lock in low longer-term rates.
  • Housing starts and sales. All housing market indicators point to a significant slowdown in activity, as the market moves to a more sustainable pace. Housing starts declined 2.5 percent in July and are down 13 percent since July 2005. Sales of both new and existing homes fell in July, by 4.3 percent and 4.1 percent, respectively.  We forecast starts and sales to continue to trend down over the rest of 2006 and 2007, although at a slower rate of deceleration than the July numbers suggest. 
  • Home value appreciation. Softening demand for housing and a build-up of inventory has curbed price appreciation, with price gains slowing to a 4.9 percent annual rate in the second quarter. Despite this sharp deceleration, price gains roughly matched CPI inflation, and we expect nominal average growth to be in the single-digits nationally through 2007.
  • Mortgage activity. Originations of one- to four-family conventional mortgages are expected to continue trending down over the remainder of 2006 as refinancing activity wanes. We project growth of mortgage debt to slow modestly, as further price gains and ongoing new construction activity support demand for mortgage debt.

No Warranties. Although Freddie Mac attempts to provide reliable, useful information in this document, Freddie Mac does not guarantee that the information is accurate, current or suitable for any particular purpose. The information is therefore provided on an "as is" basis, with no warranties of any kind whatsoever.  Opinions and estimates contained in this document are those of Freddie Mac currently and are subject to change without notice.© 2004 by Freddie Mac. Information from this document may be used with proper attribution. Alteration of this document is strictly prohibited.

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