Housing, Inflation Data Support the Fed

Tepid consumer prices and weak new construction for August may validate the jumbo rate cut, but inflation comparisons could get tougher in coming months

Was the Federal Reserve correctly anticipating tepid consumer-level inflation—and weakness in new housing construction—when it cut interest rates on Sept. 18? If reports released Sept. 19 are any indication, the answer is yes. It appears weak readings on the consumer price index (CPI) and housing starts for August helped to provide cover for the Fed's bold half-point cut in the Fed funds rate target, though both of the reports left the figures pretty much right in line with expectations.

But August may represent an oasis for inflation, as monthly comparisons will get tougher in the near future. And the housing starts figures suggest that recent credit-market turmoil had a significant impact on the month.

Here is Action Economics' roundup of the Sept. 19 reports:

Consumer price index

The overall CPI fell 0.1% in August, while the core rate, which excludes volatile food and energy prices, rose 0.2%, following gains of 0.1% and 0.2% respectively in July. As expected, energy provided a further drag on the month, falling 3.2% after a 1% decline in July and a 0.5% dip in June, with gasoline prices down 4.9% after a 1.7% drop in July. Also pulling down the headline index: Weakness in apparel prices, computers, and commodities. The housing index was flat.

The small CPI headline drop allowed the year-over-year rate to drop to 2% from 2.4%, while the expected 0.2% core gain allowed a small down-tick in the year-over-year rate for that measure to 2.1% from 2.2% in the prior three months. The headline drop in the year-over-year rate marks the likely, near-term low point, as surging energy prices and the lack of easy year-over-year comparisons in coming months should leave a surge in this measure to 2.8% in September and 3.8% by November.

The core year-over-year rate, at 2.1%, is slightly above the Fed's 2% "soft" target, but upward pressure from lofty headline inflation is in the pipeline.

The mix of CPI data paralleled the pattern for the month's producer price index report of a big 1.4% headline drop but a 0.2% core increase, as well as the trade price pattern of a 0.3% import price drop alongside a 0.1% ex-petroleum decline, and export price gains of 0.2% overall and 0.1% excluding food.

We will still assume a flat reading on the August personal consumption expenditure (PCE) chain-price gain—an inflation measure favored by the Fed—with a 0.2% core increase. Weak PCE prices were also signaled by the 2.4% gasoline sales drop in the August retail sales report. PCE chain prices in the third-quarter gross domestic product (GDP) report are poised for growth rates of 1.8% overall and 1.9% core, which keeps the core rate at the upper end of the Fed's 1%-2% target.

Housing starts

Housing starts fell 2.6% to a 1.331 million unit annual pace in August from a downwardly revised 1.367 million pace in July (from 1.381 million previously). Permits were down 5.9% to a 1.307 million rate vs. an upwardly revised 1.389 million in July (from 1.373 million previously). Single family starts fell 7.1% while multi-family starts rebounded 12.8%. Housing completions dipped 0.2%.

The August housing starts figure sits below the 1.38 million to 1.63 million range since October, leaving a drop that is likely attributable to financial turmoil. And the drop in permits to a 1.307 million rate in August suggests a lean September report as well.

We saw big drops in starts in the Northeast (37.7%) and the West (18.4%) which may reflect the skewing of jumbo loans to these regions. We actually saw bounces in the Midwest of 4.2% and the South of 11.4% that followed respective July drops for these regions of 26.3% and 11.4%.

We continue to project a 20% rate of decline in residential construction in the third and fourth quarters, following the 11.6% rate of decline in the second-quarter GDP report, as credit crunch fears take the housing sector to fresh lows.

For the monthly reports, we continue to expect existing home sales to fall by 7.8% to a 5.3 million annual rate in August, while new home sales fall by 16.1% in August to a 0.730 million pace. We still expect construction spending to fall by 0.5% in August, following the 0.4% July drop, given the 0.6% drop in August construction hours-worked following the 0.3% July decline.

Note that the National Association of Home Builders' index fell to 22 in August from 24, before falling further to 20 in September, but the Mortgage Bankers' Assn. purchase index actually bounced by 1.2% in August, and has, amazingly, entered September at a solid level.

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