Despite recent disappointing job gains, the nation’s economy will see continued steady growth averaging 3.9 percent during 2005, according to Freddie Mac’s latest economic outlook.
November’s labor market report was weaker than had been hoped for: only an 112,000 gain in payroll employment coupled with a cumulative 54,000 downward revision to the two prior months. As usual, nearly all the job gains were in the service sector (104,000 in November), and the construction sector increased hiring for the 21st time in 23 months. The unemployment rate nudged downward a tenth to 5.4 percent. The national unemployment rate has remained in a narrow band of 5.4 percent to 5.6 percent since April and is unlikely to move lower without more substantial job creation.
Consumer spending in October rose 0.7 percent and personal income was up 0.6 percent, and factory orders were also up 0.5 percent. The Institute for Supply Management’s manufacturing index rose in November to 57.8 – the first rise since July and presaging a further pickup in factory activity – and its service sector index was also up. Weakness in the foreign exchange value of the dollar should help to stimulate manufacturing activity in the new-year. The value of the dollar against the Euro has fallen by about 10 percent over the past three months.
The housing market continues at a robust pace. Interest rates on 30-year fixed-rate loans have averaged about the same amount during the past two years (5.8 percent), and with an increase of nearly 2 million jobs this has translated into vigorous housing demand. Builders have tried to keep pace by starting single-family homes at a record clip in 2004. Nonetheless, the high level of overall demand has pushed home values up. Over the past year, according to our Conventional Mortgage Home Price Index, the average single-family home gained 12 percent in value. The value gain was not shared equally across communities; those that have experienced job loss generally show the slowest gain, while markets along the coasts, where buildable land is at a premium, have seen the sharpest price gains.
Our forecast includes a further 0.25 percent increase in the federal funds target rate at the Dec. 14 Federal Open Market Committee (FOMC) meeting to 2.25 percent. As the yield curve flattens over the coming year, consumers will shy away from adjustable-rate mortgage products and away from refinance. Both, as a share of overall originations, will move downward gradually in 2005. HELOCs and closed-end second mortgage loans will continue to remain popular with consumers, perhaps helping to keep the Grinch away at year-end.
- Real GDP growth: The Bureau of Economic Analysis revised the estimate of third-quarter GDP growth from 3.7 percent to 3.9 percent, with much of the revision coming from stronger consumer spending of 5.1 percent (annualized). Due to declining energy costs we raised our fourth-quarter forecast for GDP growth to 3.8 percent, with higher growth of 3.9 percent expected in 2005.
- Consumer price inflation: Consumer price index (CPI) inflation should return to a more moderate pace, averaging 2 percent in 2005. Since its peak in late October, oil prices declined. However, we expect some effects of the high prices to filter through the economy in the fourth quarter. As a result, we raised our fourth-quarter CPI estimate from 2.5 percent to 3.1 percent. Oil prices still remain the wild card. Nonetheless, we expect oil prices to gradually drift downward in 2005, helping to keep inflation low.
- Unemployment rate: With GDP growth expected to exceed 3.5 percent, job creation should bring the unemployment rate gradually down, to close to 5 percent by the end of 2005. The November non-farm payrolls were weaker than expected and inconsistent with other indicators, especially in the manufacturing sector. As a result we believe job growth will strengthen in the coming months.
- Mortgage rates: 30-year fixed mortgage rates averaged 5.73 percent during the month of November; fixed-rate loans are only about 50 basis points above the 46-year low set in June 2003. We expect fixed-rate loans to gradually become more expensive, increasing about one-half of a percentage point between now and the end of 2005, however our average expected rate for 2005 is 10 basis points higher than our previous forecast. Adjustable-loan rates should increase by more because we expect the FOMC to continue to push the federal funds target higher; we expect another quarter-point increase, to 2.25 percent, on Dec. 14.
- Housing starts: Low mortgage rates continue to fuel new housing demand, either through household formations or desire for second homes. Our expectation for total housing starts in 2004 is at 1.96 million units, unchanged from our November outlook, and we decreased our housing starts projection to 1.8 million dwellings for 2005.
- Home sales: Both previously owned and newly built home sales will easily set records this year, of about 6.6 million and 1.2 million units, respectively. We decreased the total home sales forecast to 7.5 million for 2005, a 4 percent decline from the levels of 2004, attributable to slightly higher mortgage rates.
- Home-value appreciation: Home-price growth will moderate over the next year, to about a 7 percent annual growth rate. Strong homes sales and an improving employment outlook coupled with higher construction costs and very little buildable land in the fastest-growing areas continue to push home prices higher. Although we expect this pressure to moderate a bit with higher interest rates, we do not foresee any reason for a correction.
- Mortgage activity: The Fed-induced flattening of the yield curve (primarily through rising short-term rates) will bring the adjustable-rate-mortgage share of lending down slightly over the next year. Higher rates will also dampen refinancing volume from a share of 46 percent in 2004 to about 37 percent in 2005. After a four-year refinance boom, fewer than 1 in 7 borrowers with a fixed-rate mortgage today have an interest rate of 7 percent or higher – so very few homeowners are “in the money” for a refinance based purely on prevailing mortgage rates. Based on our higher interest rate forecast and lower home sales, we pushed down our origination forecast to $2.4 trillion for 2005 – most of the difference in origination volume is due to lower expected refinance activity. We have 2004 originations at $2.8 trillion.
This forecast was prepared by Frank E. Nothaft, Freddie Mac’s chief economist; Buchi Ramagopal, Freddie Mac’s director of financial research; and Freddie Mac economist Michael Schoenbeck.
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