Fed Eases Again; Home Building Activity Changes Little; FOMC Statement

MBA (3/19/2008 ) Velz, Orawin
The Federal Open Market Committee cut the federal funds rate by another 75 basis points to 2.25 percent, following a 50 basis point cut on January 30. The rate is now at the lowest level since February 2005.
In the post-meeting statement, the committee acknowledged that economic activity, including consumer spending and employment, has softened further. It noted that financial markets are under “considerable stress.” Tight credit conditions and further decline in the housing market will continued to weigh on growth over the “next few quarters.”

The committee paid more attention to inflation than it did in previous statements. It noted that inflation expectations have risen. While the FOMC expects inflation to moderate, it argued that inflation outlook has become more uncertain. Despite the discussion on inflation, the committee acknowledged the downside risks to growth—keeping the door open for additional cuts in April.

The fed funds rate cut decision was not unanimous. Dallas Fed President Richard Fisher and Philadelphia President Charles Plosser voted for a smaller cut. This is the second consecutive meeting that Fisher dissented and the first time that there have been two dissenting votes during Fed Chairman Ben Bernanke’s time. The Fed also lowered the discount rate by 75 basis points to 2.50 percent.

In other news, home building activity stabilized as a surge in multifamily home building activity largely offset a large drop in single-family starts. Total housing starts edged down 0.6 percent in February to a seasonally adjusted annualized rate (SAAR) of 1.065 million. Single-family starts fell 6.7 percent. This is the 11th consecutive decline in single-family homebuilding, which has now reached the lowest level since January 1991. Multifamily starts were up 14.4 percent, following a 43.6 percent surge in January (an upward revision from an initial report of 22 percent gain). Both starts of 5-and-over units and 2-4 units rose 14.5 percent and 12.5 percent, respectively.

Permits—a leading indicator of starts—fell 7.8 percent in February to 978,000 units (SAAR). This is the largest decline since January 1991 and the first time total starts fell below one million unit mark since November 1991. Single-family permits dropped 6.2 percent. This marks the 11th consecutive monthly decline in single-family permits, which reached the lowest level since January 1991.

Regional performance varied significantly. Total housing starts dropped sharply in the Northeast (27.7 percent). They increased in the South (3.9 percent) and the West (5.1 percent) and flat in the Midwest.

Through the first two months of this year, single-family starts were 38.9 percent lower than those in the first two months of 2007. By contrast, multifamily starts for the first two months of 2008 were 17.1 percent higher than those last year.

While both single-family and multifamily construction declined during the current housing downturn, multifamily homebuilding’s drop has been much more moderate. Since the peak in January 2006, single-family housing starts have declined 62 percent, compared with a 21 percent drop for multifamily starts.

Even with the sizable pullback in single-family homebuilding activity over the past two years, the housing market continues to show considerable imbalance as housing demand pulls back along with the decline in new construction. According to the National Association of Home Builders/Wells Fargo Housing Market Index released on Monday, home builders’ confidence during March continued to hover around record low levels reached in December 2007.

Despite aggressive rate cuts by the Federal Reserve thus far, housing demand continues to be sluggish. Builders reported that many potential buyers are either reluctant to purchase or they are unable to qualify for a mortgage, given tighter lending standards. In addition, the spread between conforming mortgage rates and the benchmark 10-year Treasury yields has widened significantly.

While the number of homes available for sale dropped steadily over the past 10 months, the months’ supply for new home rose to 9.9 months in January, the highest level since October 1981. Given the huge overhang of unsold inventory in many parts of the country and soft housing demand, a sharp pullback in housing starts is necessary to reduce the market’s excess supply.

A separate report showed that both the overall and the underlying (core) wholesale prices picked up. The Producer Price Index (PPI) rose 0.3 percent in February, following a 1.0 percent increase in January. Excluding the volatile food and energy items, the core PPI rose 0.5 percent in February, the biggest increase since November 2006. From a year ago, the core PPI was up 2.5 percent, accelerating from 2.4 percent.

The stock markets rallied before the FOMC meeting, helped by better expected earnings from Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc., alleviating credit concerns. Treasury yields increased as funds moved from Treasuries to stocks. The yield on the 10-year Treasury note stayed around 3.46 percent by mid-Thursday afternoon, 15 basis points higher than the closing rate on Wednesday.