More slow growth expected in economy

Economic growth will continue to slow through the rest of 2006 but should return to near normal growth during 2007 and 2008, according to the latest economic forecast released this week by the Mortgage Bankers Association. Total residential mortgage production in 2006 is expected to be $2.46 trillion, the fifth-highest level ever, but will drop another 14 percent in 2007 to $2.1 trillion and remain unchanged at that level in 2008.

“Despite sluggish growth, largely due to declining residential investment and auto production in the second half of this year, we are optimistic about a rebound in 2007,” said Doug Duncan, MBA chief economist and senior vice president for research and business development. “Long-term interest rates have remained low in the face of rising short-term rates, equity prices have risen nearly 20 percent, capital expenditures remain strong, the trade sector has turned from a big drag on growth to a modest stimulus, and energy prices have dropped sharply.”

In his general session presentation at MBA’s 93rd Annual Convention & Expo in Chicago, Duncan said, “although the labor market has recently weakened, the market is still quite healthy. Employment continues to expand moderately, with payrolls increasing at an average monthly pace of 120,000 over the past three months. Several measures of core inflation have trended higher in recent months, but we are optimistic that they will decelerate slowly to below the upper-end of the Fed’s comfort zone.”

Financial markets perceive that the Federal Reserve is finished with its tightening cycle and expect the top monetary policymaker to ease its short-term rate hikes in 2007, Duncan said. “Although we expect core inflation to moderate going forward, we believe that the currently elevated rate will keep the Fed from lowering interest rates despite signs of slowing economic activity.”

The MBA expects the Fed to keep the fed funds rate steady at the current 5.25 percent through 2008.

Meanwhile, rates on fixed-rate mortgages are now below 6.4 percent, Duncan said. “We expect long-term rates to remain low this year, helping to cushion the slowing in residential housing activity that has been underway for more than a year. Commercial real estate activity should remain a bright spot in the economy.”

Duncan said the 30-year fixed-rate mortgage yield should trend “modestly higher” over the next two years, reaching 6.8 percent by the end of 2008.

Other key points noted in the forecast:

• Real GDP growth will average about 3.1 percent in 2006, 3 percent in 2007 and 3.2 percent in 2008.

• The unemployment rate will increase from the current level of 4.6 percent to 4.9 percent by the end of 2006 and to 5.2 percent by mid-2007 and remain there through 2008. MBA expects the labor market to add an average of about 90,000-100,000 jobs monthly over the next 12 months.

• Fixed mortgage rates are expected to remain at about 6.3-6.4 percent through the rest of the year. Rates are expected to rise to about 6.7 percent by the end of 2007 and to about 6.8 percent by the end of 2008.

• The yield curve remains inverted, with the fed funds rate and the 1-year Treasury yield exceeding the 10-year Treasury yield.

• The yield spread between fixed- and adjustable-rate mortgages has remained at its lowest levels in more than five years. The share of adjustable-rate mortgages has declined from 30 percent at the beginning of the year to 20 percent in August, according to the Federal Housing Finance Board (which includes only conventional loans for home purchase). MBA projects the decline in the share will continue through the forecast period, reaching about 19 percent by the end of 2008.

• The ARM share from the Mortgage Bankers Association weekly survey of mortgage applications (which include both purchase and refi loans) has shown a much more modest decline, however. The ARM share remained elevated at nearly 27 percent of the number of loans by mid-October, compared with about 30 percent at the beginning of the year.

• Total existing-home sales for 2006 are forecast to decline by about 9 percent relative to 2005, and will pull back by about another 8 percent in 2007. New-home sales are expected to decline by nearly 18 percent from a record high in 2005 but to slip by about 8 percent in 2007. Both new- and existing-home sales are forecast to increase modestly in 2008.

• Existing-home price appreciation is expected to slow significantly this year, with median price gains decelerating to about 2.5 percent. Median new-home price gains are projected to moderate to about 1 percent. Price gains for both existing and new homes in 2007 are expected to be similar to those in 2006. Home-price appreciation should strengthen modestly in 2008.

• Residential mortgage originations for purchase loans will reach $1.39 trillion in 2006 and will edge down to $1.32 trillion in 2007. Residential refinance loans will total $1.07 trillion in 2006 and then decline to $807 billion in 2007. For 2008, both purchase and refi originations should remain relatively flat to their 2007 levels.

• Total residential mortgage production in 2006 will be $2.46 trillion, the fifth-highest level ever, declining by about 19 percent from an estimated $3.03 trillion in 2005 (the second-highest level ever). Total mortgage originations should decline an additional 14 percent to $2.12 trillion in 2007 and should remain flat in 2008.

• The risks to the forecast lie mainly on the downside, MBA said. The housing sector could deteriorate more than projected, with sharper declines in single-family housing starts and home sales, resulting in sustained declining year-over-year home prices. This could lead to a marked slowdown in consumer spending growth. If so, the Fed could start easing to prevent a recession. However, if core inflation remains elevated or even edges higher, the Fed would likely remain on the sideline, increasing the risk of a recession. The MBA believes the probability for this scenario to be small.

The MBA revised its estimate of total mortgage originations in 2005 to reflect newly released data from the Home Mortgage Disclosure Act and the MBA Survey of Mortgage Originations.