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U.S. Housing Poised to Recede
Oct 21, 2005
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Frustrated that steadily increasing the federal funds rate in quarter-percentage-point increments hasn't driven up the low long-term mortgage rates that have helped fire up the housing market in recent years, the Federal Reserve will continue tightening into early 2006, when housing activity should start flattening out below this year's torrid levels, NAHB Chief Economist David Seiders said.

"The housing market is seeking out a peak," said Seiders, and while it is still too early to conclude that it has found one--with housing starts increasing 3.4 percent in September and third-quarter performance exceeding expectations--there is growing evidence that the Fed has started to hit its mark and housing will begin losing some of its exuberance in the period ahead. "The power of long-term interest rates for housing is incredible," said Seiders, and key to the housing outlook is where those rates are headed. The rates on 30-year fixed-rate mortgages reported weekly by Freddie Mac have been moving up over the past month, he pointed out, and are now above 6 percent.

In his housing forecast, Seiders is predicting that long-term mortgage rates will rise by another 60 basis points by the third quarter of next year, bringing them to about 6.6 percent. The Federal Reserve will decide to boost its federal funds rate by one-quarter of a percentage point at each of its next three meetings, he predicted, bringing it to 4.5 percent at the end of January when Fed Chairman Alan Greenspan's term runs out. Most likely, that will be the rate at which the central bank decides that its policies have reached neutrality, neither stimulating nor slowing down the economy.

Greenspan has discovered that it's no longer as easy to slow down housing as it used to be, and the Fed has run into difficulty in taking some of the steam out of a boom that it believes has been running too hot and cannot be sustained. The proliferation of "exotic" adjustable rate mortgages (ARMs) such as interest-only and payment-option loans, along with a rise in speculative buying that has been boosting home purchases and prices in hot markets, has strengthened the Fed's determination to gain control over the housing sector, he said.

NAHB is forecasting a decline in total housing starts from 2.032 million this year to 1.94 million in 2006 and a further drop to 1.883 million in 2007. After that, the annual production of new housing units (including manufactured homes) should settle around 2 million units, which is within the 1.9 million to 2.1 million rate that is sustainable on average for the 2003-2013 period, he said. "We have been running a tad above that," Seiders said, "but the comedown shouldn't be all that dramatic."

Single-family construction is projected by NAHB to decline from 1.683 million starts this year to 1.590 million in 2006 and 1.533 million in 2007. Multifamily output, however, should remain close to the 349,000 level expected for this year through 2007. With vacancy rates falling and condominiums becoming oversupplied in some markets, the composition of the multifamily market should shift a bit away from condos and back to market-rate rentals, he said.

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