Are We There Yet?

Are we there yet? Children ask that question endlessly on a long car trip. Federal Reserve officials are asking it about their drive to curb inflation.

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One month, we are going to imagine economists humming the lyric from a ‘60s tune, “I can see clearly now,” as we read their reports. But not this month.

The April employment report certainly suggested blue – or at least bluer – skies in that sector. Employers created 288,000 new jobs and the unemployment rate declined from 6.7 percent to 6.3 percent.

“The economy was frozen and now it has thawed out,” Stuart Hoffman chief economist for PNC Financial Services Group, told the Wall Street Journal. Although most agreed with that optimistic assessment, the employment report still generated more than a few of the “yes-buts” that seem to have been baked into economic forecasts since the recovery began. Yes, employers appear to be hiring at impressive levels again, but, some analysts pointed out, the unemployment rate declined because so many people have exited the job market, not because so many unemployed workers found new jobs.

“Terrific on the surface, but disappointing underneath,” is how New York Times columnist Nate Silver described the employment data.

Housing Indigestion

It is the housing market, however, that continues to produce indigestion in analysts looking to home sales and new home construction to drive economic growth this year, leading some to suggest that this sector may now be doing more to impede growth than to stimulate it.

The March and April housing statistics did little to dispel those concerns. Existing home sales in March slipped 7.5 percent below the year-ago level, falling to the lowest annual pace in nearly two years. New home sales plummeted by more than 13 percent year-over year, declining to an annual rate of 384,000 units. Home starts, which had been falling for several months, revived a bit in March, but still fell below projections, primarily because of a decline in multi-family construction. Single-family starts actually increased by nearly 3 percent, while single-family permits (an indicator of future construction activity), increased by 7 percent.

That wasn’t enough to lift the spirits of homebuilders, however. Confidence levels, measured by a National Association of Home Builders (NAHB) index remained subdued, moving marginally higher in March compared with the previous month, but remaining below the 50 percent level marking the dividing line between optimism and pessimism. A Credit Suisse report showing that foot traffic in 40 markets was 33 percent below the year-ago level was hardly encouraging.

Home prices, which have been posting steady year-over-year gains, are still doing so. The Case-Shiller home price index registered an annual gain of 13 percent in February. But despite that evidence of continued strength, analysts see cause for concern about the housing outlook. Continued weakness in new and existing home sales, combined with the prospect of higher interest rates as the Federal Reserve continues to phase out the “quantitative easing” that has kept loan rates in check, have led Robert Shiller, co-founder of the Case-Shiller index, to conclude that continued momentum in the housing market “is not a safe bet.”

A “Faltering” Recovery

David Blitzer, chairman of the index committee at S&P Dow Jones Indices, is even more concerned. The weakness in housing construction and home sales suggests to him that the housing recovery “is faltering.”

With the arrival of spring failing to produce the usual spurt in home buying activity, it is getting harder for analysts to blame the severe winter for the continued weakness in sales. The problem, some analysts say, is more fundamental – a lack of homebuyer demand.

Higher mortgage rates and even more, higher home prices have driven investors, who had been snapping up bargain-priced foreclosure sales, out of the market. But more than anything else, their departure has revealed that the housing market was not as strong as it had appeared to be – built on the shifting sands of investment buyers rather than on the more sustainable demand from prospective homeowners, who have not filled the gap created as investors have retrenched.

The dearth of first-time buyers has been a particular problem, many analysts say. Household formation rates have dipped as a weak job market has made it impossible for many young adults to rent apartments or purchase homes of their own. (Sales of entry-level homes costing less than $100,000 fell 18 percent year-over-year in March, compared with a 10 percent decline for homes between $100,000 and $250,000 and an 8 percent increase for homes priced at $1 million or more, according to industry statistics.)

Rising home prices propelled in part by cash-paying investors and higher mortgage rates have combined to push affordability levels down. Skimpy inventories, meanwhile, continue to put upward pressure on home prices. The housing market, to some extent, “has been a victim of its own success,” Lawrence Yun, chief economist for the National Association of Realtors (NAR), suggested in a recent industry report.

Positive Signs

The cure for what ails the housing market is fairly straightforward: “Our main challenge is housing demand, and that means we need more people forming households,” Stan Humphries, chief economist at Zillow, told The New York Times, recently.

Employment holds the key to unlocking the household formation door, and the recent jobs report suggests that we may be seeing the beginning of a positive trend in that area.

An easing of the credit standards that have made qualifying for a mortgage difficult for many buyers would also help, and there appears to be evidence of movement here, too. In the Federal Reserve’s most recent Loan Officers’ Survey, 16.7 percent of the respondents said their institutions have loosened underwriting standards, while only 5.6 percent said they had moved in the opposite direction.

Consumer confidence is another prerequisite for stronger housing demand and there’s potentially good news here. The Thomson-Reuters confidence index for April reached its highest level since last July. The reading (82.6) wasn’t exuberant, but, coupled with a 3 percent increase in consumer spending, it provides “unambiguously constructive” evidence that consumers are “back in the game,” Milan Mulraine, an economist at TD Securities, told MarketWatch.

The proof, of course, will be in the home sales pudding, and here, again, recent indicators contain positive hints. The NAR’s pending sales index rose to 97.4 in March compared with an upwardly revised 94.2 for February. That is still 7.3 percent below the year-ago reading, but it “hints at resurgence,” Gennadiy Goldberg, U.S. Strategist at TD Securities, told the Wall Street Journal. The question, of course is whether this upward movement will translate into stronger sales, and whether that trend will be sustainable.

On that score, you won’t find many analysts more optimistic than Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities, who is holding fast to his forecast for 1.2 million new home starts this year, even as most industry analysts (including the NAR’s Yun) are scaling back their projections for new and existing home sales.

“I’d be surprised if we didn’t see starts up 25 percent to 30 percent by December from where they are now,” LaVorgna told WSJ.

That is certainly a pleasant prospect. Whether it’s a realistic forecast remains to be seen.