In Housing Starts, Forget April Watch The Rebound

When housing starts plunged 17% in April, most analysts were stunned, and alarm bells started ringing at the Federal Reserve. To Cassandras who have tended to view the economic recovery as shaky, the specter of a collapsing housing sector only confirmed their warnings that a triple dip in economic activity was a growing possibility.

Fortunately, the 11% May rebound in starts--the largest in 15 months--has weakened the force of such dire predictions. "The robust showing of starts in May," says economist David W. Berson of the Federal National Mortgage Assn., "indicates that residential construction will continue to contribute to economic growth through the year."

Over the near term, that contribution should be considerable, despite recent volatility in the monthly numbers. Economic activity depends on the number of units being built, not simply started, and because this includes construction begun as much as six months ear- lier, the effect of the sharp rebound in starts earlier this year will continue to boost economic activity through the summer. Indeed, the number of single-family homes under construction has been rising sharply in recent months (chart).

According to Berson's projections, residential construction should add about 0.6% to the economy's growth rate in the second quarter and 0.4% in the third. And that doesn't count the secondary effects, as the housing upturn sparks sales of appliances and furniture.

The outlook could brighten. A number of elements supporting housing construction seem to be falling into place. Mortgage rates have been trending down since mid-March and are now below 8.6% for a 30-year fixed rate, a five-month low. Builders report a modest easing in credit conditions in many areas of the country. Housing affordability is at its strongest level since the mid-1970s, and mortgage applications, which fell sharply in April, have started to turn up again in recent weeks.

The biggest clouds on the horizon are a recent weakening of new-home sales and a softening of builder optimism. According to the National Association of Home Builders' June survey, some 28% of builders of single-family homes described their current sales pace as poor, and 43% said that traffic of prospective home buyers was "low to very low."

Still, only 15% of builders in June expected sales of single-family houses to be poor over the next six months, compared with 30% anticipating good sales. nahb economist David Seiders predicts that "a lot of pent-up demand will surface once income and job growth picks up." To which Fannie Mae's Berson adds: "Any surprises in the housing sector are likely to be on the up side."

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