With a better job market, the next test of the resilience of this expansion will be higher mortgage rates. Unexpected strength in employment growth was good news indeed, but the flip side to a stronger economy is that the Fed will likely raise rates if the job growth is sustained.
Though there are many reasons to believe that the housing market will remain robust through 2004, the risk of a serious downturn in the next few years is clearly increasing – particularly in areas of the country where home prices have risen the most. Affordability is at the heart of the housing market’s vulnerability to rising interest rates because it is the ability to afford the payments on a high-priced home that is directly affected when rates rise, not the actual home price. Additionally, rising use of adjustable-rate mortgages increases the risk for more homeowners not being able to afford their homes when interest rates rise.
Economic Growth: C
Non-seasonally adjusted employment posted a surprising gain in March, exceeding expectations by a wide margin with the addition of 653,000 jobs. This was a strong improvement over the previous month and is the highest annual growth figure since first quarter 2001. Indicative of solid employment growth, initial claims for unemployment insurance fell sharply to 328,000 for the week of April 3, which was the lowest since the week ending Jan. 13, 2001.
Leading Indicators: B-
Though slipping a bit to 10.1 percent in March, the six-month growth rate of the ECRI Weekly Leading Index continues to be relatively high. While the six-month growth rate remains below levels seen in the summer of 2003, a clear upward trend continues for the index and indicates that economic recovery will maintain a steady forward pace in coming months.
Mortgage Rates: A
March’s surprising employment report pushed mortgage rates higher, with the average 30-year fixed mortgage rate rising more than a quarter-point in one week from 5.52 to 5.79 percent. The bond market reacted swiftly to Friday’s employment report, resulting in a drop in bond prices that pushed yields and mortgage rates higher. A stronger-than-expected jump in job growth fueled market speculation that the Fed will raise interest rates in early third quarter.
In addition to weak employment growth, low inflation has been the other linchpin holding down interest rates during this recovery. Despite high prices at the gas pump, the CPI showed little annual change in February. However, if the economy continues to grow, inflation will likely perk up and take interest rates along with the rise. Once there’s evidence of this occurring, we’ll likely see the Fed’s fiscal and monetary stance shift from one of stimulus to that of constraint.
Consumer Behavior: C
Though the job market showed surprising gains in March, consumers haven’t taken much notice. Both the consumer confidence and consumer sentiment indexes showed upward, but marginal, change last month. Perceptions about the present and future employment situation weighed heavily on the index. The good news, however, is that recent declines in consumer confidence have reversed and indicate gains going forward.
Existing-Home Market: B+
Existing-home sales rose to 6.12 million annualized sales in February, as inventory ticked up to 4.6 months. This is still a strong showing and is nearly 6 percent above year-ago levels.
New-Home Market: B+
Annualized sales of new homes jumped to 1.16 million in February, posting a 24 percent year-over gain and the highest level since August of 2003. The median new-home price rose to $205,500, a 10 percent annual gain and new all-time high.
Housing Supply: C+
While starts slowed in February, mostly due to stubbornly severe winter weather, permit activity picked up, indicating that home-building activity will likely post an increase in the months ahead.
John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis. Rebecca Wood, Ph.D., V.P., was the primary author of this article.
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