Eye on the Economy: Housing Wealth Effect Will Weaken  Economic growth is coming off the first-quarter surge, and a period of below-trend GDP growth lies ahead. This adjustment process should help extend the life of the current economic expansion for at least several more years.
Employment growth is slowing down with the growth in economic output (real GDP). This process should restore more slack to labor markets before long, an essential element of an extended economic expansion with low inflation. Core Inflation Is Bubbling Up Core inflation has been firming up as the expansion has matured and labor markets have tightened, and high energy costs have been leaking into the core thorough business cost structures. Core inflation now is colliding with the upper bounds of various Federal Reserve “tolerance ranges.” Recent statements by Fed Chairman Ben Bernanke and other Federal Reserve officials show much greater concern about upward pressures on core inflation than about the evolving economic slowdown, even though much of the core inflation issue can be traced to a highly controversial housing component. It’s now virtually inevitable that the Fed will enact yet another quarter-point rate hike at the conclusion of the next Federal Open Market Committee (FOMC) meeting on June 29, and further increases can’t be ruled out. Stock and Bond Markets Are Reeling The Fed’s display of anti-inflation resolve, combined with similar positions taken by various foreign central banks, have put heavy hits on U.S. and global stock markets while lowering longer-term inflation expectations among financial market participants. These developments have fostered a modest decline in long-term interest rates during the past month, but long rates will firm up before long. The Housing Slowdown Is on Track The “moderate” and “orderly” housing slowdown appears to be on track, marked by systematic declines in mortgage applications, home sales and housing starts as well as by a slowdown in house price appreciation. This process should extend well into next year as long as our broad economic and financial market forecasts stay on track. The projected “soft landing” for housing in 2006 and 2007 certainly will have some geographic rough spots, including previously “high-flying” markets as well as “earthbound” markets where economies have yet to stage meaningful lift-off following the 2001 recession. Housing Production Swings From Growth Engine to Drag On a national basis, housing production now is transitioning from a strong engine of economic growth to a drag on GDP growth. The projected contraction in residential fixed investment is the key component of the evolving and projected slowdown in growth of real GDP. The Housing Wealth Effect Will Weaken Only Gradually Support to the economy provided by large capital gains on housing and associated stimulus to personal consumption expenditures undoubtedly will wane as time passes, but this shift will not be abrupt. Equity in owner-occupied housing displayed solid growth in the first quarter, reaching a record $11.4 trillion despite the slowdown in price appreciation and ongoing borrowing against housing equity. | 
