Friday, April 29, 2005

Tale of Two Economies

MSNBC.com

Latest reports tell tale of two economies
Housing continues to soar even as overall expansion slows
By Martin Wolk
Chief economics correspondent

When Federal Reserve Chairman Alan Greenspan and his central banking colleagues hold their next meeting Tuesday, they will confront a series of recent reports telling a tale of two economies.

Even as the housing sector continues to soar, everything else about the economy seems to be just muddling along.


This week’s initial estimate of gross domestic product for the first quarter confirmed a sequence of reports on retail sales, manufacturing orders and consumer confidence suggesting that the economy slipped into a soft patch in March, cooling a bit sooner and more sharply than forecasters had expected.

Meanwhile new-home sales surged to record levels, indicating that the nation’s long housing boom still has some steam left despite rising short-term interest rates.

“I would say this is a little bit of a soft patch,” said Gus Faucher, senior economist at Economy.com. “We’re not going to see a big acceleration in growth, but we are not going to slow from these levels. We are kind of in the soft landing phase.”

Most economists agree the GDP slowdown to an estimated 3.1 percent rate from 3.8 percent in last year’s fourth quarter is nothing to get alarmed about but more of an expected and even desired outcome of the Fed’s 9-month-old tightening cycle, with a bit of a push from high oil prices.

“If you put it in historical context, this is a very positive number,” said Rich Yamarone of Argus Research, who is not known as one of the more bullish economists on Wall Street. “The economic expansion continues with very few inflationary pressures.”

Frank Fernandez, chief economist for the Securities Industry Association, described the slowdown as a “moderate cyclical downturn” and stressed that it is not a “prelude to outright recession.”

He sees GDP growth slowing to 3.3 percent this year and 2.5 percent next year, compared with 4.4 percent last year.

“I think the economy is going to slow further,” agreed Quincy Krosby, chief investment strategist for The Hartford. “It’s a global synchronized slowdown,” driven at least in part by higher oil prices, she said.

But she said the slow growth means that inflation is not a major concern, so the Fed will not have to raise interest rates more aggressively.

In fact, crude oil prices fell sharply this week, closing below $50 a barrel for the first time in two months, which should make central bankers more confident that inflation is unlikely to rise much higher from current levels.

As a result, the Fed will almost certainly raise short-term interest rates another quarter-point Tuesday and probably again June 29 at the mid-year meeting of policy-makers. That would bring the benchmark overnight lending rate to 3.25 percent, compared with 1 percent when the rate-hike cycle began in mid-2004.

Although the GDP report including an inflation reading that was slightly higher than expected, Faucher said noted that the Fed is unlikely to express concern because there is still enough slack in the labor market that there is little apparent pressure to boost wages.

The housing market, however, is beginning to trigger more alarm bells.

“It’s gotten more and more speculative,” said Ethan Harris, chief U.S. economist at Lehman Bros. “The housing market seems very divorced from economic fundamentals now. It does feel like what was a moderate so-called bubble forming in the economy has become a much-bigger disconnect.”

Like many analysts who look at the market, Harris sees not a national bubble but a number of regional markets that are developing overheated conditions, including much of California, much of Florida and possibly parts of the Northeast.

For now, the growing housing market is helping to pull the rest of the economy along -- like a compact car towing a huge trailer, as Harris describes it. Residential investment grew at a brisk 5.7 pace in the latest quarter, but housing sales boost consumer spending and economic activity in many other ways as well.

Harris does not see a collapse anytime soon, it is easy to envision a scenario where regional housing markets run into trouble and further cool the national economy, he said.

Harris pointed out that investor activity in housing appears to have accelerate substantially over the past two years, with one industry trade group estimated that more than more than one-third of all homes purchased last year were either for investment purposes or second homes.

“If you look to the year ahead that is the thing I’m watching most closely in terms of risks to the economy,” said Harris.

While long-term rates remain near their lowest levels in 40 years, Harris points out that a growing number of buyers are relying on adjustable-rate mortgages either because they are planning to “flip” the home or because that is the only way they can afford to buy.

Some of these mortgages are “hybrids” with low introductory rates that could jump substantially as the Fed continues to push rates higher.

“At some point we’re going to see one of these regional markets run into trouble, and that could spread into the other hot markets,” Harris said. And that could lead to a downturn in consumer psychology and a further economic slowdown, he said.

URL: http://www.msnbc.msn.com/id/7681478/