During the second quarter of 2005, total home sales and house price appreciation reached their peak in the 2002 -- 2005 Housing Boom. Home values grew at an energetic rate of 15.4 percent annualized and home sales (including condos) hit a record of 8.48 million in the quarter.
All economic indicators supported a robust mortgage market: GDP was solid, at a 3.3 percent annualized rate, payroll employment grew by 500,000 that quarter, and 30-year fixed-rate mortgages were at a relatively low 5.7 percent. At that time we knew that the housing market would not continue along this path indefinitely and we predicted a sizable moderation in housing activity in 2006. A year later, the second quarter numbers for 2006 are more moderate as expected. The summer of 2005 signaled a turning point in housing activity from a metaphoric heat wave to a "moderate and orderly cooling."
Looking forward, the U.S. economy is in a complicated position with mixed economic signals creating uncertainty for financial markets, business, and consumers. Rapid first quarter growth is expected to be replaced by slower GDP growth at a 2.8 percent annualized rate. Consumer prices sprinted upward in the second quarter, as oil prices edged up near $75 a barrel and the consumer price index, excluding food and energy, grew at a seasonally adjusted annual rate of 3.1 percent in the first five months of 2006, compared to a 2.2 percent increase for all of 2005.
Moreover, oil prices seem to be driven not only by supply constraints and global demand but also by geopolitical concerns, which are much harder to predict. Furthermore, the Institute for Supply Management reported tepid growth in June in the manufacturing and service sectors, signaling weakness in economic activity. The Labor Department reported that the economy added a lower than expected 121,000 jobs in June, thus payroll employment grew by 175,000 fewer jobs than the second quarter a year ago. On June 29 the Federal Reserve Board responded to these economic signals by raising the federal funds rate to 5.25 percent. Whether the U.S. will see another elevation in the federal funds rate in August will depend on the Fed's outlook for inflation and growth.
In the second half of the year the markets, businesses, and consumers will need to adjust to an economy in transition from above trend growth driven in large part by a housing boom to below trend growth exacerbated by higher energy prices and a cooling housing market. As a result we expect some volatility in mortgage rates as they continue to bounce around a gently rising trend, averaging 6.8 percent over the remainder of the year for 30-year fixed-rate mortgages. In addition, investors in the housing market that were once emboldened by the expectation of strong house price appreciation may now contribute to waning housing demand.
According to the National Association of Homebuilders, lower demand, coupled with affordability concerns and higher interest rates, decreased homebuilder optimism in June to its lowest level since April 1995. Providing another indication of shrinking demand, the National Association of Realtor's Affordability Index reached its lowest level in over fifteen years. Though the direction of housing activity is unambiguously heading cooler, we remain confident that the climate is still temperate and that 2006 will finish as the third strongest year ever for the national housing market.
