| NAHB is forecasting modest declines in home sales and housing starts in 2004, primarily because of an anticipated firming up of the interest rate structure as the year progresses. But there’s some down-side risk to those interest rate forecasts and some up-side risk to the housing forecasts. Indeed, incoming data show that the danger of price deflation in the U.S. economy is not yet behind us, that the productivity wave is keeping labor markets weak and that both these factors have been weighing on the bond market and our central bank. The Fed holds monetary policy steady but begins to craft an exit strategy … The Federal Reserve held monetary policy steady at the Jan. 28 meeting of the Federal Open Market Committee (FOMC), maintaining the 1% federal funds rate target it first established on June 25 of last year. Furthermore, the FOMC decision once again was unanimous. The FOMC’s public statement contained an assessment of recent economic performance that was quite similar to the assessment delivered at the conclusion of the last FOMC meeting on Dec. 9, although the Fed had to stretch a bit this time to make the case for an “improving” labor market (resorting to unspecified indicators other than new hiring). The FOMC’s characterization of the risks to sustainable growth, and to the inflation situation, were virtually identical as well. But the FOMC altered the bottom-line assessment of how it views policy prospects going forward, dropping the statement that “policy accommodation can be maintained for a considerable period” and saying that the FOMC “can be patient in removing its policy accommodation.” This subtle shift actually was a loud heads-up that weakened the Fed’s apparent open-ended commitment to the 1% funds rate and reminded the markets that short-term rates will have to go up at some point. The knee-jerk reactions in financial markets sent long-term interest rates up and stock prices down. NAHB’s forecast still shows a 1% federal funds rate until the Nov. 10 FOMC meeting, but the fed funds futures market priced in higher probabilities of earlier increases on the heels of today’s FOMC statement. We still believe that a rate hike late in the year is the best bet. Consumer confidence is reviving slowly, held back by on-going concerns about the labor market … Consumer confidence (Conference Board series) picked up in January, following a bit of erosion in December. But the overall measure still was well below the pre-recession peak and not far off the cyclical low last spring. Furthermore, the improvement has been paced by the forward-looking expectations component, while consumers’ assessments of the present economic situation have remained pretty much in the doldrums. The Conference Board stressed that consumers’ view of current economic conditions in January “remains both weak and volatile” and “strongly hinges on improvements in the labor market.” Ironically, anticipated improvements on the job front helped to lift consumer expectations about the economic situation six months down the line. Consumers seem to be expecting the same thing that NAHB is forecasting and that the White House undoubtedly prays for every day. Monetary and fiscal policies are “working” despite the persistently weak job market … The persistent weakness of the labor market (both job creation and hourly earnings) through the end of 2003 does not mean that “stimulative” monetary and fiscal policies are failing to work. After all, both types of policies are designed to stimulate spending by consumers and businesses, and the immediate measure of success is a higher rate of economic output (GDP). Improvements in the job market normally follow a pickup in growth of economic output, although it’s fair to say that the time lag is inordinately long this time. The double-barreled policy stimulus actually has been quite dramatic. The Fed’s aggressive easing of monetary policy through mid-2003 reduced interest rates and increased credit availability, and the current benefits include higher bond and stock values as well as a lower dollar. On the fiscal front, the tax-cut legislation enacted on July 1 has boosted disposable personal income, provided incentives for business capital investment and strengthened stock values (lowering the cost of equity capital). It’s perfectly clear that this package of economic policies has stimulated both spending and economic output. But a major surge in growth of labor productivity enabled the business sector to meet the stronger demand for economic output in the second half of 2003 with little net increase in payroll employment and with only minor increases in average hourly earnings. History suggests that such a pattern is unlikely to persist much longer. Decent job growth should emerge during the first half of 2004 and growth of average hourly earnings should pick up in the process. Jobs matter most on the political front, and growth in jobs and earnings is not yet assured ... The anticipated improvements in the labor market could be prevented, of course, by persistently high productivity growth and/or a slower-than-expected rate of economic output. It must be admitted that productivity growth is particularly hard to forecast, especially when businesses still have large amounts of unutilized capital equipment from the investment boom of the late 1990s, and some components of the recent tax-cut legislation certainly favor business investment in new labor-saving capital equipment. Thus, the anticipated pickup in growth of jobs and hourly earnings is hardly a foregone conclusion, even if strong growth in economic output is realized, and the condition of the nation’s labor market is likely to be a key issue throughout this year’s political campaign. History shows that the most important economic factors in presidential elections are: - The growth rate of real per capita disposable income over the year preceding the elections
- The unemployment rate immediately before the elections
NAHB’s base-case (most probable) forecast of these variables strongly favors re-election of President Bush, but there obviously are substantial risks to realization of those forecasts. Some Democratic candidates already are calling the evolving economic upswing a “Republican Recovery” that strengthens corporate profits, business investment and the stock market while leaving the great American worker behind — partly because of the structure of the 2003 Bush tax cut package. That label could prove to be hard to shake in coming months. And then there’s the drain of American jobs to places like China and India … As if the productivity explosion hasn’t created enough complications for the U.S. labor market in an election year, American workers are now also seeing more and more of their jobs gravitate to places like China and India where the cost of equivalent labor is a small fraction of the U.S. wage scale. This process has been going on for some time in manufacturing and involved large and controversial job losses to Japan and Mexico. Now the job drain increasingly involves service jobs such as operating call centers and computer coding and programming. In essence, many of America’s lower-skilled workers are being priced out of the global labor market by competition from abroad, creating a good deal of pain and tremendous uncertainty here at home. Democrats vying for the presidential nomination this year have cited rising job insecurity stemming from the loss of jobs to foreign countries as part of their attack on President Bush’s economic record. The President, for his part, is proposing more federal dollars for job training and retraining but he certainly has not condemned competition in the global labor market or in the global markets for goods, services or financing. Fed Chairman Greenspan spoke out on this topic on Jan. 27. Greenspan stressed that deregulation, financial innovation and flexible labor markets have contributed to long-term job growth, increased the U.S. standard of living and made our system better able to withstand economic shocks. He also went on to discourage protectionism that could turn out to be counterproductive and destabilizing. The chairman’s logic presumably is on target, but the conclusions certainly don’t ring well with displaced workers in places where decent employment options are not available. The only way to diffuse this hot issue before November is to get job growth going, and that’s going to require a pace of spending and economic output that virtually forces American businesses to step up hiring here at home. | 
