Rising Economic Risks for the National Outlook

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By Danushka Nanayakkara-Skillington

The U.S. economy has shown steady – if unspectacular –growth during the past eight years. Between 2010 and 2017, the economy has grown on average by 2.2 percent. However, this is less than the economy’s 50-year growth rate of 3.5 percent and lags the average annual growth rate in the years between the tech bubble burst (2001) and the Great Recession (which began in 2007).

During the past nine years, the economy’s potential rate of growth has been 1.5 percent. This potential, estimated by the federal government, reflects the maximum sustainable rate of economic growth. Although actual gross domestic product (GDP) growth has fallen behind pre-recession rates, it has exceeded the average potential rate during the same period. As a result, actual and potential overall GDP has converged, indicating that the U.S. economy is nearing a national recovery. Even though GDP growth in 2018 is expected to hold steady, partly due to tax cuts, the expectation for 2019 is a deceleration in growth as interest rates rise.

The economic recovery also has been characterized by sustained job growth. As a result of the Great Recession, the number of jobs around the country sank to 94 percent of the total, pre-recession (138.4 million). Since reaching this low point, payroll employment has climbed steadily, rising 8 percent above the peak number of jobs prior to the last recession.

Sustained job growth has contributed to a decline in the unemployment rate. After peaking at 10 percent due to the Great Recession, the unemployment rate has steadily fallen, dropping to a historically low rate of 3.7 percent in October, the lowest level since 1969. By these metrics, labor market conditions have normalized. At the same time, continued job growth at its current pace will meet resistance unless more people enter the labor force.

In addition, home prices continued to rise in August. This continued home price appreciation reflects broader economic growth and tight inventory across the county. Since house price appreciation has exceeded per capita personal income growth, concerns about homeowner affordability have become serious. In fact, the NAHB/Wells Fargo Housing Opportunity Index, a housing affordability measure, finds that only 56 percent of new and existing home sales were affordable for a typical family in late 2018. This measure of affordability conditions marks a 10-year low.

Concerns about housing affordability have been aggravated by the increase in mortgage rates in 2018, which are expected to rise in the coming two years to more than 5 percent. Rising mortgage rates largely reflect the rising rate of the 10-Year Treasury Note, which itself parallels the trend in the federal funds rate. Taken together, it suggests that mortgage rates have been rising because monetary policy has been tightening.

Single-family starts also have been supported by improving economic conditions resulting from low mortgage rates. However, the rate of growth in single-family production has shown evidence of a general deceleration.

As a result of this growth, single-family starts ended 2017 at 852,000, 96 percent above their recession-related low of 434,000 in 2011. At the same time, single-family starts are only 67 percent of the average level during the 2000 to 2003 period, just prior to the excesses of the housing boom. In other words, single-family production has benefited from economic conditions, but its current below-normal level still reflects the steep decline in response to the last recession.

Underlying economic fundamentals have strengthened across the states and Washington D.C. (hereafter “states”) since the end of the last recession, but most of the leading growth states are in the western and southern regions of the country. To some degree, the strength of a state’s underlying economic fundamentals informs the extent of the recovery in single-family starts. At the same time, the pace of recovery, a return to the average level of production between 2000 and 2003, also reflects the depth of the contraction in production during the recession.

Although the broad macroeconomic trends, both nationally and across each state, will increasingly govern trends in housing production, the effects of the last recession have not fully faded. All states experienced a steep contraction in single-family building activity. Some states, such as Nevada, Illinois, California, and Georgia, fell greater than the national average when we measure single-family starts relative to normality or the average annual level between 2000 and 2003. These states remain further from returning to that level, in large part due to the depth of their specific decline.

In contrast, states such as Wyoming, Louisiana, Alabama, Oklahoma, and Texas, to name a few, did not fall as far, although these states did experience a steep contraction in single-family building activity as well. Partly due to the comparatively shallower decline in response to the recession, the number of single-family starts in these states is closer to normality.

However, states such as Idaho and Utah represent states where the decline was steep but the growth has been strong to the point that the number of single-family starts now exceeds their 2000 to 2003 level. This growth from recession-induced lows reflects the strength of their underlying economies.

Relative to normality, all states are expected to move closer to normality by the end of 2020. States across the West and the South will be the leaders, while many lagging states will be concentrated in the Midwest and the Northeast. Despite relatively strong underlying economic fundamentals, states like California continue to lag other states in their single-family production recovery because of the deep decline experienced during
the recession.

Approximately 20 percent of states should return to normal levels of production by 2020. However, the risk of a recession is rising, and it could soften production after our forecast window. If a recession were to arrive sooner than expected, then it could lower production to levels below our current forecast.

Danushka Nanayakkara-Skillington is the AVP, Forecasting and Analysis for the National Association of Home Builders (NAHB) in Washington, D.C. She can be reached at dnanayakkara@nahb.org.

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