The housing sector crested during the autumn of last year, with a gradual slowing continuing this spring. New construction eased in April to 1.85 million homes (seasonally adjusted, annual rate), the least in nearly a year and a half. House and condominium sales also remain below third-quarter 2005 levels, and the inventory of unsold homes has increased to near a six-month supply in April, about 20 to 25 percent above fall's levels. The softening buyer interest in homes also resulted in a marked slowing in home-value appreciation, from 13.7 percent (annualized) during the third quarter to 8.7 percent during the first quarter -- albeit still well above general consumer price inflation. Anecdotal reports from local markets around the U.S. refer to a shift from a "seller's" market to a "buyer's."
A decline from the records set in 2005 -- records set for single-family starts, home sales, and real home-value growth (that is, adjusted for general inflation) -- was inevitable. High levels of home prices and rising mortgage rates for both adjustable-rate and fixed-rate loans have pinched potential buyers' budgets and reduced the overall affordability of homeownership. Indeed, during the first quarter of 2006 the homeownership rate dipped to 68.6 percent, the lowest in about two years.
In reviewing various measures of housing market performance, Federal Reserve Chairman Bernanke observed at the annual Conference on Bank Structure and Competition last month that the sector was experiencing "a very orderly and moderate kind of cooling." We expect that gradually rising interest rates will slacken overall demand further, resulting in construction and home sales off about seven percent from 2005's record pace. Even with that, the sector will enjoy its third best year ever, surpassed only by the stellar volumes of each of the past two years.
The housing sector is not the only industry that may be experiencing a moderation in activity. May's labor market report revealed lackluster job growth of only 75,000 nationwide; taken with the 37,000 downward revision to March and April's jobs data revealed very modest employment growth over the past two months. Manufacturing lost 14,000 jobs. Construction, which has experienced a housing driven spurt in employment levels over the past few years, added only 1,000 jobs in May, consistent with other measures of moderation in the residential market.
The disappointing labor market report coupled with evidence of a moderating housing sector did have a bright lining: Long-term interest rates eased somewhat in early June, reflecting some cautious optimism in the market that core inflation will remain contained and within the Fed's targeted range. Overall price inflation, as measured by the Consumer or Producer Price Index (CPI or PPI), has accelerated over the past year primarily due to the record levels of energy prices. The core of these indexes (which exclude food and energy prices) has remained relatively low and stable, up only 2.3 percent for the CPI and 1.5 percent for the PPI on an April-over-April basis.
The increase in mortgage rates over the past several months will reduce refinance levels and overall origination volumes. Compared with the third quarter of last year, the coming July-to-September period may see dollar volumes lower by about 25 percent. Lower home sales will be largely offset by home-value gains of about the same proportionate magnitude, resulting in purchase-money volume that is essentially unchanged from the prior year. But a 50 percent drop in refinance originations (in dollars) will translate to lower overall single-family lending during the third quarter, compared with a year earlier. The continuation of a relatively flat yield curve with low long-term rates also means that the ARM share of lending will remain under pressure, with lenders continuing to offer sizable initial-period rate discounts to encourage ARM borrowing.
