Driving Home the Point by Freddie Mac Chief Economist
Housing continues to be a pivotal driver of economic growth. This was clear with the latest revision to the first quarter GDP growth figures, which registered housing consumption and investment at 22 percent of GDP growth over the first three months of this year. The strong support that housing activity has provided to the overall economy is further demonstrated by including consumer spending related to renovations and home buying. Separate from housing consumption, residential fixed investment (RFI) accounted for 15 percent of first quarter nominal GDP growth. RFI primarily consists of spending on new construction and renovations, but also includes real estate sales commissions. During the spring, new housing starts and home sales continued at a brisk pace, but single-family starts were off slightly from the record pace of the first quarter. However, new and existing home sales were poised to set another quarterly record during the second quarter. Thus, housing will continue to be an important component that sustains economic growth, although its contribution to growth will likely be less than its first-quarter stimulus. The robust housing activity is directly related to the level of mortgage rates. The dip in 30-year fixed-rate mortgage rates to a 14-month low in June rekindled housing demand and sparked the record pace of sales activity. Adjustable-rate mortgage (ARM) rates have also remained low as lenders have gradually increased the amount of the initial-rate discount offered on these products. For example, during the last week of June, the average fully indexed rate on a 1-year ARM was 6.24 percent compared with an average starting rate of 4.24 percent, or a 200-basis point discount. This is the largest initial-rate discount on a 1-year ARM in more than five years. Larger rate discounts, and a proliferation of ARM products that offer payment flexibility (such as the "interest-only" and "option-payment" products) have kept the ARM share of originations close to one-third of primary market production. The ARM share is likely to hover around that level for much of this year before moving lower next year as the Fed continues to raise short-term interest rates. Ah yes, the Fed. According to the June 30 FOMC statement, the Fed continues to view monetary policy as accommodative. It maintains the position that it has room to move toward a neutral monetary policy at a "measured" pace. In plain English, we expect the Fed to set the federal funds target at 3.5 percent on August 9 -- a quarter-point increase timed with its next FOMC meeting, and consistent with the "measured" steps that it has taken over the past 13 months. The Fed is concerned with what it sees as near-term inflationary pressures in the economy. Some of these pressures come from record levels of crude oil prices, which have hovered near or slightly above $60 a barrel over the past month; the tragic bombings in London heighten the degree of economic uncertainty and may increase "risk premia" in futures contracts. Chairman Greenspan has also expressed concern over house-price "froth" in some local markets across the U.S. According to data from LoanPerformance, investor and second-home lending, as a share of single-family purchase-money originations, has crept up over the past year, and accounted for about 20 percent of the number of prime, conventional loans during the first quarter of 2005 -- nearly double the level of six years ago. While speculative fervor could contribute to house price gains in some local markets, we expect home-value appreciation to moderate over the coming year as mortgage rates gradually move higher. | 
