The U.S. Economy Is Just Starting to Tap Into a Big Source of Dry Powder

Acceleration in housing is inevitable.

There's a big reason to believe that the U.S. economy will be able to withstand the start of the Fed tightening cycle: There's still plenty of pent up activity in the housing sector. And it's hard to see the U.S. economy running out of steam with this much upside left in residential investment, according to some economists and analysts. 

Going back to the 1940s, the U.S. central bank has never embarked upon a tightening phase with housing having so much room to run to the upside.

Macquarie, Bloomberg

This chart shows residential investment's share of nominal gross domestic product, with the start of the previous six rate hike cycles denoted with a circle.

The severity of the housing bust prompted activity in this sector to stay at depressed levels, even with the Great Recession getting farther away in the rear view mirror.

Residential investment accounts for 3.34 percent of nominal gross domestic product, as of Q2 2015, well below its long-run average of 4.56 percent, as Macquarie analyst David Doyle has observed. The Fed has not initiated a series of rate hikes at a time when residential investment's share of gross domestic product is more than one standard deviation below its long-run average since at least 1970.

"Business cycle expansions are likely when residential investment is low as a share of GDP," wrote Doyle. "Recessions typically only transpire when residential investment becomes elevated as a share of GDP."

While there is plenty of upside for construction activity, the availability of workers to carry this out is more suspect.

Neil Dutta, head of U.S. economics at Renaissance Macro Research in New York, noted that the relative strength of the labor and housing market makes for quite an abnormal dynamic.

"What is interesting about this is that the housing market is accelerating at a time when the labor market is near full employment," he said.

He suggested that any shortage of construction workers could be remedied by displaced mining employees and higher wages to attract additional labor.

The unemployment rate, which dipped to 5.1 percent in August, has rapidly converged upon the Federal Reserve's estimates for the non-accelerating inflation rate of unemployment, which is a range of 5 percent to 5.2 percent. That is, monetary policymakers think that 5 percent is the lowest the unemployment rate can get before inflationary pressures start to arise.

Labor slack has been eliminated at a rapid pace, though broader measures of the health of the jobs market suggest work remains to be done.


On a recent interview on BloombergTV, New River Investment portfolio manager Conor Sen indicated that the U.S. single-family housing market would enjoy a strong secular tailwind over the next 10 to 15 years as millennials formed households and shifted from renting to owning homes.

Sen separately observed that single-family housing starts, as a share of the prime age population (25 to 54 years old), remain at very subdued levels. If single-family starts normalize to 1.25 million, more than 250,000 workers would be needed to erect them, assuming that the ratio between starts and residential construction jobs reverts to what it has averaged since the start of 1985.

Dutta concurred with the demographic support for construction activity, pointing out that children born in the 1980s, when the birth rate was climbing, will make up the next batch of first-time homebuyers. He also noted that cyclical forces, such as easing lending standards and rising homebuilder confidence, buoy the outlook for the sector.

"Bad things do not happen to America when housing is moving up and to the right while Americans are finding jobs," said Dutta.

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