| The unemployment rate gravitated downward during the year and we’re estimating an increase in payroll employment of 2.24 million over the course of 2004 (December to December). Further above-trend growth in real GDP should maintain positive labor market developments going ahead. Inflation is firming up as the economic expansion proceeds … Price inflation picked up in 2004 on the heels of a deflation scare in the latter part of 2003, but inflation fundamentals remained reasonably good as the year drew to a close. “Core” inflation, as measured by both the chain-core Consumer Price Index and the core market-based price index for Personal Consumption Expenditures, approached 2% late in the year (measured on a year-over-year basis). While still historically low, the upward gravitation of core inflation (excluding prices of food and energy) certainly did not escape the attention of the central bank in 2004. The Fed is in the midst of an extended process of rate hikes … The Federal Reserve held the federal funds rate at 1% during the first half of 2004 in order to help solidify the economic expansion and insure against a deflation problem in the U.S. The Fed began to move off this extraordinarily stimulative monetary policy stance on June 30, and the funds rate now stands at 2.25%. Although the real (inflation adjusted) federal funds rate now is positive, the current monetary policy stance still is stimulating the U.S. economy. The Fed wants to get back to a more “neutral” stance as long as economic growth continues to sop up slack in resource markets (labor and capital) and continues to generate inflationary pressures. NAHB’s forecast shows a federal funds rate of 3.75% by the end of 2005. We’re expecting quarter-point rate hikes at the February, March, May and June meetings of the Federal Open Market Committee, with a less aggressive process during the second half of 2005. Bond prices continue to defy gravity but long-term interest rates should firm up soon … Long-term rates held in a narrow range in 2004, closing out the year at about the same levels that prevailed when the year began. Indeed, long rates gravitated downward during the second half despite the series of hikes in short rates kicked off by the Fed on June 30. The stock market enjoyed a late-year surge and an accompanying bond sell-off moved long-term rates up to some degree in the waning days of 2004. NAHB’s forecast shows a percentage-point increase in long-term rates over the course of 2005, a move that takes the long-term home mortgage rate to 6.75%. The factors behind this move include the projected pattern of Fed policy, a falling dollar and further upward pressure on core inflation — partly from the labor market. The housing picture remains bright despite mixed signals in late 2004 … The housing sector turned in a great performance in 2004, thanks largely to the behavior of long-term interest rates. New records were set for single-family home sales and housing starts as well as for condo units in multifamily housing. Low interest rates also buoyed the rental housing market, in the face of record-high vacancy rates. Key data on housing for November presented quite a mixed picture. On the negative side, housing starts fell by 13%, sales of new homes fell by 12% and issuance of building permits fell by 1.5%. On the positive side, sales of existing homes climbed by 3% in November to a new monthly record, NAHB’s Housing Market Index edged up in November (and in December), and the Mortgage Bankers Association’s index of applications for mortgages to buy homes showed strong readings for both November and December. Everything considered (including weather effects), it appears that the housing market remains fundamentally sound and is poised to turn in an excellent performance next year. NAHB’s forecast shows some modest slippage in market activity for 2005, with home sales and single-family starts receding to the second highest levels on record. It’s probably time to count our blessings. | 
