Neither the Federal Reserve’s minutes to April’s Federal Open Market Committee meeting nor Chair Janet Yellen’s speech this week gave any clear indication of a time frame for interest rate liftoff. Fed Chair Yellen said an initial rate liftoff this year is “appropriate” if the economy continues to improve as forecast. She expects the subsequent pace of hikes to be gradual, although in keeping with the Fed’s data dependency mantra, the pace of tightening could speed up or slow down. She added, though, that the Fed still hasn’t hit its employment goals just yet, and that should rule out June definitively, and likely July too. Inflation is also expected to be moving up toward the 2% target as the economy strengthens. We continue to think the first rate hike will come in September, especially given April’s core inflation of 1.8%.
The few economic releases this week include:
- Housing starts grew to an annual rate of 1.135 million in April from a revised 0.944 million (was 0.926 million) in March–a seven-year high.
- Existing home sales fell by 3.3% to an annualized rate of 5.04 million in April from an upwardly revised 5.21 million (was 5.190 million) in March.
- The Philadelphia Federal Reserve Index of Manufacturing fell to 6.7 in May from 7.5 in April.
- U.S. Leading Economic Indicators grew 0.7% in April from a revised 0.4% (was 0.2%) in March.
- The Consumer Price Index (CPI) in April rose by 0.1% following the previous month’s growth of 0.2%. Excluding food and energy prices, the core CPI rose by 0.3% after increasing by 0.2% in March. Year-over-year core CPI rose 1.8%.
- Initial jobless claims fell to 274,000 in the week ended May 16 from the previous week’s unrevised level of 264,000. Continuing claims remained unchanged at 2.211 million in the week ended May 9.
Housing Springing Forward
In a sign that homebuilders are feeling more confident and the spring housing surge is here, new housing starts rose by 20.2% in April (from March), bringing the annual rate up to 1.135 million. This is a new high for housing starts since December 2007 and is a big rebound from weather-induced first-quarter weakness. April starts increased by 9.2% from a year ago.
Building permits, which are a leading indicator for future building activity, also point to the U.S. housing sector strengthening. Permits for new home construction were up 10.1% to a 1.143 million pace. The gap between permits and starts narrowed with the unwinding of first-quarter weather distortions despite big gains for both, as starts are more weather-sensitive than permits.
Data from the Northeast and Midwest provide evidence of a big first-quarter weather impact. There were large gains for starts in the Northeast (86% in April and 115% in March) after a huge 59% two-month plunge through February. There were also huge rebounds in the Midwest, with gains of 28% in April and 30% in March after a 39% two-month plunge that was similar to the weather-related decline in 2014. For regions less affected by weather, starts in the West surged 39% after falling 18% in March, while starts in the South fell 2% after a 1% dip in March.
And it wasn’t just the multifamily housing that showed strength. The all-important single-family starts climbed 16.7% to a 733,000 annual rate. This is a welcome sign given that this recovery has been marked by wide differences between the two categories–the multifamily component has climbed back to its prerecession levels while the single-family component still has much to gain. In 2015, single-family starts are up a 14.7% year over year, with multifamily up only 0.5%. Momentum in this category seems to have picked up.
We believe that both the supply and demand conditions are much better now than they were a year ago for single-family home construction. The real dollar volumes of construction and land development loans began to rise year over year in 2014, the first time since 2009. According to the Fed’s Senior Loan Officer Survey, builders have been facing more favorable credit conditions as demand for new construction picks up. Homebuilder confidence is positive overall as builders are benefiting from lower wage pressure and cheaper materials. The price of lumber has been dropping since February. That said, negative pressures in some areas do exist. For example, water cutbacks in California might provide less than previously expected construction in the West, while a slowdown in the energy sector will dampen some of the new construction activity previously expected in the South and Midwest.
Moreover, the stringent regulatory hurdles that first-time homebuyers must clear to qualify for mortgages are expected to be loosened. The labor market picture is also considerably brighter now, and we anticipate that wage growth will pick up this year, and income growth should counterbalance the expected rise in effective mortgage rates. Home prices are still climbing, although the pace of the climb has slowed somewhat.
We expect housing starts to climb to 1.1 million units in 2015 and 1.4 million units in 2016.
And the rise in starts should help increase the supply of new homes to come in the market after completion and take some pressure off lagging housing supply in existing homes. Existing home sales dipped 3.3% in April but remained above the 5 million annualized rate mark. The National Association of Realtors (NAR) viewed the rise in prices of existing homes in the market due to tight inventory (median existing home sale price rose 8.9% year over year) as dampening some of the gains in sale in previous months. The NAR noted that “roughly 40 percent of properties sold last month went at or above asking price, the highest since NAR began tracking this monthly data in December 2012.” Rising prices pose an impediment to sales activity, but we expect house price inflation will slow in the coming months as housing supply rises.
Unsold housing inventory remains a drag on sales activity, representing only 5.3 months at the current sales pace, still low on a historical basis. The average 30-year, conventional, fixed-rate mortgage, meanwhile, fell 10 basis points in the month to 3.67% as rates remain historically low and supportive of activity.
We foresee pent-up demand, rising incomes, and solid underlying fundamentals supporting a gradual housing recovery this year.