Tuesday, November 28, 2006

Bernanke: Economic Outlook

by Bill McBride on 11/28/2006 12:33:00 PM

Chairman Bernanke spoke today in New York: The Economic Outlook . A few excerpts, first on Q4 GDP:

At this juncture, information about economic activity in the fourth quarter is limited, and the range of plausible outcomes remains wide. But the indicators in hand suggest that real GDP growth this quarter is likely to be in the same general range that it was in the second and third quarters.
On housing:
... a slowing in the pace of house-price appreciation was inevitable. Moreover, the sustained rise in prices, together with some increase in mortgage interest rates, sowed the seeds of the correction by making housing progressively less affordable. Declining affordability ultimately served to limit the demand for housing, leading to a deceleration in house prices and slowing home purchases.

The drop in home sales that began earlier this year has led homebuilders to curtail the rate of new construction. Indeed, single-family housing starts are down about 35 percent since their peak earlier this year. Obtaining a precise read on home prices is difficult: During a period of weak demand, potential sellers often choose to leave their homes on the market longer or even to remove them from the market, rather than accept price offers that are below their expectations. The timeliest data on house prices do not fully account for changes in the composition of home sales by location, size, and other characteristics. Moreover, the data do not capture hidden price cuts, as when builders try to stimulate sales through the use of "sweeteners" such as paying the customer's mortgage points or upgrading features of the house at no additional cost. Nevertheless, there can be little doubt that the rate of home-price appreciation has slowed significantly for the nation as whole. Some areas have continued to experience gains--albeit smaller ones than before--while other markets have seen outright price declines.

Notwithstanding the sharp reduction in starts of new single-family houses, inventories of both new and existing homes for sale have increased markedly this year. For example, according to the most recent data, homebuilders currently have about 550,000 new homes for sale, roughly half again the number that has been typical during the past decade. Moreover, the official statistics likely understate the full extent of the inventory buildup, as many homebuilders have reported a sharp increase this year in the number of buyers canceling signed contracts. A home for which the sales contract is cancelled becomes available for sale once again but is not included in the official data on the inventory of unsold new homes. To reduce this inventory overhang, builders are likely to continue to limit the number of new homes under construction.

Although residential construction continues to sag, some indications suggest that the rate of home purchase may be stabilizing, perhaps in response to modest declines in mortgage interest rates over the past few months and lower prices in some markets. Sales of new homes ticked up in August and increased a bit further in September. The University of Michigan's survey of consumers shows an increase in the share of respondents who believe that now is a good time to buy a home, from 57 percent in September to 67 percent in November. Meanwhile, an index of applications for mortgages for home purchases has been trending up since July. Although these developments are encouraging, we should keep in mind that even if demand stabilizes in its current range, reducing the inventory of unsold homes to more normal levels will likely involve further adjustments in production. The slowing pace of residential construction is likely to be a drag on economic growth into next year. emphasis added
A reasonable description of the current housing situation.

Bernanke also acknowledges the slowdown in manufacturing:
Growth in some manufacturing industries has also slowed of late, and data prepared by the Federal Reserve show that aggregate manufacturing production declined in September and October. The motor vehicle sector in particular has experienced weaker demand and an accompanying buildup in stocks of unsold cars and trucks over the past year.
Bernanke also notes the downside risks:
Like all economic forecasts, this one is provisional, and risks exist in both directions. On the downside, the correction in the housing market could turn out to be more severe and widespread than seems most likely at present. A deeper correction would directly affect economic activity through additional cutbacks in housing starts and through its effects on employment in construction and housing-related industries. More indirectly, it might also impose greater restraint on consumer spending by reducing homeowners' equity and thus household wealth, and perhaps by affecting consumer confidence as well. Because consumption makes up more than two-thirds of aggregate expenditure, any significant effect on consumer spending arising from further weakness in housing would have important implications for the economy.

On the other hand, economic growth could rebound more vigorously than now expected. The solid rate of job growth, the decline in the unemployment rate, and the healthy pace of capital investment could be signals that underlying economic fundamentals are stronger than generally recognized. Moreover, to date there is little evidence that the weakness in housing markets is spilling over more broadly to consumer spending or aggregate employment. If these trends continue, growth in real activity might return to a pace that could intensify upward pressures on resource utilization.
The downside is clearly more likely.