| The best inflation news is provided by the Fed’s favorite price gauge, the core price index for personal consumption expenditures (PCE). This measure was up by only 1.5% in the third-quarter GDP accounts, the same as the second quarter. Furthermore, the core PCE price index was up by the same year-over-year pace in October — according to a report released Wednesday by the Commerce Department. Another rate hike by the Fed is likely on Dec. 14 … The Fed’s assessment of economic conditions at the conclusion of the Nov. 10 meeting of the Federal Open Market Committee (FOMC) has proven to be on target. Furthermore, policy is still highly accommodative, with a real federal funds rate that’s barely positive. These circumstances argue for another quarter-point rate hike at the next FOMC meeting on Dec. 14 as the Fed continues to tighten monetary policy at a “measured” pace. This adjustment will raise the federal funds rate target to 2.25% and take the bank prime rate to 5.25%. Long-term rates are also on the rise … Until recently, long-term interest rates remained stubbornly low despite good economic performance, a firming inflation picture and the series of Fed rate hikes that began on June 30. But long rates have backed up during the past month and further increases are in store for the balance of this year and in 2005. NAHB’s forecast shows about a percentage point increase in bond and mortgage rates over the coming year. The Fed presumably wants long-term rates to rise as the central bank hikes the short end of the yield structure. Indeed, Chairman Alan Greenspan recently talked long rates up (and the dollar down) by suggesting that foreign investors (including foreign central banks) should consider the possibility of over-concentration of their portfolios in dollar-denominated assets such as Treasury securities. Home sales hold firm and the near-term outlook remains bright … Sales of both new and existing homes were essentially flat in October, holding at a near-record pace in both markets. It’s now perfectly obvious that home sales will post new annual records in 2004. Indeed, this year’s performance should surpass the previous record (2003) by nearly 10%. Surveys of both single-family builders and home mortgage lenders show that the single-family market remained fully in gear during November. The NAHB/Wells Fargo Housing Market Index was flat at a historically high level, and the Mortgage Bankers Association’s series on applications for mortgages to buy homes showed essentially the same pattern. 2005 may be tougher for builders to navigate … Home builders operated in a very favorable economic and financial market environment in 2004. But inventories of unsold homes moved up during the year, buyer resistance to high home prices is growing, and financial market conditions promise to be less favorable in 2005. Builders must focus on the changing environment to make the most of the next year. Builders should be prepared to deal with some weakening of home buyer demand in 2005. This means, first of all, placing strict controls on inventory accumulation. Second, builders should mine the adjustable-rate mortgage (ARM) market for all it’s worth. ARMs financed nearly half of all new-home purchases in 2004, with particularly heavy usage in high-priced areas, and a similar share is likely in 2005 despite some narrowing of the initial ARM interest rate advantage. Builders also should be prepared to roll out special sales techniques and incentives that have been successful in past periods. Indeed, a special NAHB survey conducted last November showed heavier usage of realtors/brokers as well as a rising incidence of sales incentives. At that time, 28% of builders were including optional items in homes at no charge, about one-sixth were paying closing costs or financing points, and some companies had begun to “buy down” mortgage interest rates. | 
