Here's the economic outlook from Fred Furlong of the San Francisco Fed, along with twelve graphs in support of his conclusion that "the picture of the economy looking forward ... is ... marked by slumping residential building activity (and related sectors) on the one hand, and solid performance in the rest of the economy on the other":
FedViews, FRBSF: Fred Furlong, group vice president, Financial Research and Applied Microeconomic Research, at the Federal Reserve Bank of San Francisco, states his views on the current economy and the outlook:
The advance estimates of GDP from the Bureau of Economic Analysis show real output grew at a 1.3 percent annual rate in the first quarter of this year. While sluggishness in business investment has damped overall growth in recent quarters, the picture of the economy looking forward still is expected to be one marked by slumping residential building activity (and related sectors) on the one hand, and solid performance in the rest of the economy on the other.
Residential investment contracted at a 17 percent annual rate in the first quarter, knocking off about 1 percentage point from annualized real GDP growth. In the fourth quarter of last year, residential construction fell at a rate of more than 19 percent, trimming overall growth by about 1-1/4 percentage points.
Among the other main sectors, business fixed investment recovered somewhat in the first quarter of this year, growing at a 2 percent annual rate, after contracting in the previous quarter. The most recent monthly data on orders of core capital goods suggest that business investment is likely to pick up further in the current quarter and in coming quarters.
Growth in consumer spending in the first quarter was a solid 3.8 percent annual rate. The monthly pattern for real consumer spending did show some progressive weakening in the quarter, and in March, real consumption contracted at a 0.2 percent monthly rate. The cutback in spending in that month was accompanied by a modest increase in the saving rate. The saving rate, which is in negative territory, reflects the rise in household wealth that has been boosted for several years by strong house price appreciation and rising stock prices. In the coming quarter, consumer spending growth is expected to slow somewhat in response to the deceleration in house price appreciation and even to declines in house prices in several markets in the wake of the sharp shift in demand for housing.
Housing starts and permits have been adjusting to weaker demand for new single family housing, with permits in the 1.5 million unit per year range in recent months. There is still the risk that residential investment will slip further given the sizeable overhang of inventories of unsold new single family homes, the rise in the homeowner vacancy rate, the still weak demand for single family houses, and the tightening of credit conditions for home mortgage borrowers.
Payroll employment increased 88,000 in April, putting the three-month average rate at about 118,000 per month, compared to the more robust pace of about 195,000 over the previous three month period. The slower job growth was accompanied by a rise in the unemployment rate of only 0.1 percent in April to 4.5 percent, leaving the rate near the low end of the range of estimates of the NAIRU (non-accelerating inflation rate of unemployment).
The moderation in job growth during the three months ending in April was relatively broad-based. Not surprisingly, one of the sectors posting job losses was residential construction. However, the adjustment of jobs in this sector has lagged considerably behind the contraction in building activity. For example, real residential investment was off by 13 percent in 2006, on a fourth quarter to fourth quarter basis. Measured on a comparable basis, jobs in this sector were down by only about 0.5 percent. In the first quarter of this year, the differential at annualized rates was nearly the same, with a 17 percent decline in residential investment matched by a drop of only 5 percent in employment.
This stark difference in the adjustment of output and jobs in residential building suggests that some of the recent slowing in labor productivity growth is temporary. Output per worker hour in the nonfarm business sector rose only 1.6 percent in the fourth quarter of 2006 compared to a year earlier. In the first quarter, the productivity measure was up 1.7 percent at an annual rate. Based on our estimates of the change in productivity in residential building and the relative value-added contribution of this sector in 2006 and the first quarter of 2007, the sector imposed about a 0.5 percentage point (annualized) cyclical drag on nonfarm business productivity growth. Looking forward, this effect is expected to unwind as the adjustment in employment catches up with the decline in output.
Core consumer prices, as measured by the PCE price index, were unchanged in March, moving the 12-month inflation rate down to 2.1 percent—about average for the past 3 years.
With our forecast for real GDP keeping output expanding at somewhat below our estimate of potential, we see a small further move in core PCEPI inflation to 2 percent through the end of next year.
The market was fully expecting the FOMC to hold the federal funds rate steady at 5.25 percent at its meeting on May 9. While there was some response on the announcement, the market’s view on monetary policy did not appear to change appreciably. Based on prices in interest rate futures and options markets, market participants expect the FOMC to remain on hold over the next few meetings, but are still looking for subsequent rate cuts.
Outside of mortgage markets, domestic credit market conditions have not changed noticeably. In particular, estimated term premiums remain quite low, leaving the 10-year Treasury yield at about the same level as in late June 2004, when the FOMC initiated the first of 17 rate hikes. Also, risk premiums on corporate bonds have edged up only slightly and remain relatively modest.
Similarly, the Federal Reserve Senior Loan Officer Opinion Survey on Bank Lending Practices for April 2007 shows a slight net easing of credit standards on commercial and industrial loans to large and medium size businesses. That same survey does show a net tightening of credit standards on commercial real estate loans among the domestic bank respondents, though the recent tightening phase preceded the flare-up in the subprime residential mortgage market.
Credit standards on residential mortgages have become tighter. Also, the jump in spreads on subprime residential mortgage-backed securities are consistent with increases in interest rates charged to subprime borrowers; though interest rates on benchmark 30-year fixed rate mortgage have moved with the 10-year Treasury yields.
While standards have tightened, lenders continue to originate subprime real estate loans and the volume of non-agency residential mortgage-backed securities through the early part of this year indicates continued support from securitization.