Fed Leaves Target Rate Unchanged; New Home Sales Drop

MBA (6/26/2008 ) Velz, Orawin
As widely expected, the Federal Open Market Committee (FOMC) held the federal funds rate steady at 2.0 percent. This is the first time since September 2007 that the FOMC has met without cutting interest rates.
In the post-meeting statement, the committee noted that the economy continued to expand—a more upbeat remark than the previous statement in April that economic activity “remained weak.”

The FOMC was more optimistic about consumer spending, noting that it was firming. It appeared to be more optimistic about the housing market, describing the housing downturn as "ongoing," compared with “deepening” in the previous statement. It listed a number of factors that will likely constrain growth, including the deteriorating labor markets and tight credit conditions in addition to the housing market.

Regarding inflation, the FOMC continued to say that inflation is expected to moderate, but given the continued increases in energy and commodities prices and elevated inflation expectations, there is still a great deal of uncertainty surrounding the inflation outlook.

The committee did not adopt an explicit bias toward tightening; however, unlike the previous statement where the committee made no reference to risks to growth or inflation, yesterday’s statement said that downside risks to growth have diminished, while upside risks to inflation have increased.

The fed funds rate decision was not unanimous. Dallas Fed President Richard Fisher voted for a rate increase. This was his fourth consecutive dissent this year.

Yesterday’s economic reports continued to show weak housing and manufacturing activity. New homes sales were down 2.5 percent in May to a seasonally-adjusted annualized pace of 512,000, following a 4.8 percent increase in April. Sales of new homes during the first five months of this year were down 37.5 percent from the same period last year. Sales have declined about 63 percent since their peak in July 2005.

Sales increased in two regions: 5.1 percent in the Midwest and 0.4 percent in the South. Sales declined in the West and the Northeast by 11.6 percent and 7.9 percent, respectively.

The number of homes available for sale fell 1.7 percent to 453,000—the 13th consecutive monthly decline and the lowest level since May 2005. The steady decline in inventory reflected considerable cutbacks in single-family homebuilding.

A drop in inventory and a slower sales pace pushed the months’ supply up from 10.7 months in April to 10.9 months in May—the fourth highest reading since the inception of the series in 1963. Following an increase of 0.4 percent in April—the first in five months—the median price resumed its drop, falling 5.7 percent in May from a year ago. The significant excess supply in the new home market suggested that new home prices will likely trend down further.

Another indicator of sluggish housing demand was the continued increase in the length of time that houses have spent on the market. The median number of months rose from 7.9 in April to 8.5 in May—the highest level since record keeping began in August 1988. The median number of months on the market averaged 5.7 months in 2007.

Builders’ confidence continued to erode, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index, which fell in June, matching the record low reached in December 2007. The Housing Market Index is considered one of the leading indicators of future home sales because it also captures builders’ expectations of sales over the next six months. The purchase index from the Mortgage Bankers Association’s weekly survey of mortgage applications, which has continued to trend down in May through mid-June, also indicated weaker housing demand in the near-term.

Given eroding builders' confidence to such a low level and softer purchase mortgage demand, new home sales will likely be weak through the second half of the year. In its June mortgage finance forecast released on June 11th, MBA projected that home sales will hit bottom in the fourth quarter of this year at 506,000 units (seasonally adjusted annualized rate)—the slowest quarterly pace since the first quarter of 1991

A separate report showed flat demand for durable goods. New orders for manufactured durable goods were unchanged in May, as the increase in the volatile civilian and defense aircraft orders offset broad-based declines elsewhere. Excluding the volatile orders for transportation equipment, orders fell 0.6 percent after two consecutive monthly increases.

Shipments for nondefense capital goods excluding aircraft—a component used in the calculation of economic growth in the current quarter—rose 0.6 percent. The figure for April was revised upward to 0.9 percent from 0.5 percent, which bodes well for second quarter economic growth.

The report indicated weaker future business investment spending, however. Nondefense capital goods orders excluding aircraft—a proxy for business investment in equipment and software in the coming quarters—dropped 0.8 percent, following an increase of 3.1 percent (revised down from a 4 percent increase).

Treasury yields were little changed. The yield on the 10-year Treasury note edged up two basis points and stayed around 4.11 percent by mid-Wednesday afternoon