Freddie Mac Finds Evidence of Economic Growth
October 9, 2002
by Frank Nothaft and Amy Crews Cutts
National income accounting is based on a simple identity: GDP is the sum of consumption, investment, government spending, and net exports. Evidence that economic growth accelerated to about 4% (seasonally-adjusted annual rate, or SAAR) during the third quarter comes from each of these components. Zero-percent automobile finance deals ignited a rebound in durable goods expenditures by consumers, which are projected to increase 18% (SAAR) during the July-to-September quarter. Business fixed investment - structures, equipment, computer software - will grow at a 4% (or better) clip, the first quarterly increase in two years. Government spending for national defense will likely grow another 10% (SAAR) this quarter. Even net exports (exports less imports) are likely to improve a bit based on the weakness of the dollar, contributing a little bit toward economic growth.
The sustainability of these components to overall GDP activity is another question. Lousy stock market performance has continued to eat away at household wealth, and recent manufacturing data point toward weak factory orders and continued plant overcapacity. State and local government spending could weaken in the fourth quarter as tax receipt shortfalls force budget cutbacks. Thus, fourth-quarter economic growth is likely to be much weaker - projected at 2% growth (SAAR). This has raised the possibility of another Fed rate cut. At their September 24 meeting, the Federal Open Market Committee (FOMC) experienced a rare lack of unanimity, with 10 members voting to keep the federal funds rate where it was and 2 voting for a cut. Regardless what happens at the November 6 FOMC meeting, it is clear that low interest rates will be with us for a while.
Since the start of September, 10-year Treasury yields have dropped about 0.5%, driven by a weak economy, low inflation, poor stock market performance, and a "flight to quality" fueled by heightened uncertainty regarding military conflict in the Mideast. Mortgage rates have declined to 36-year lows, but they have not fallen as much as Treasury yields. Uncertainty over interest-rate volatility has increased the "cost" of the prepayment risk embedded in mortgage rates, resulting in widening mortgage-to-Treasury spreads. Expect 30-year fixed-rate mortgage rates to hover near 6% through to the start of 2003.
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- The economic outlook is mixed, with the 4th quarter showing a potential for greater weakness than originally anticipated. We have lowered our forecast for real GDP growth to 2% (SAAR) for the 4th quarter but increased our forecast for the quarter just ended to 4% (SAAR). These revisions leave the .annual growth rate of 3.1% for 2002 and 3.4% forecast for 2003 unchanged
- Inflation is still keeping a low profile, however recent spikes in energy prices caused a rise in the Consumer Price Index for August. Thus far, for 2002, inflation as measured by the CPI has been running at a 2.7% annual rate. We are expecting growth in consumer prices of 2.3% over the second half of the year.
- The Unemployment rate unexpectedly fell to 5.6% in September. However, the employment numbers for September were bleak with 43,000 jobs lost, sending a mixed signal. On the bright side, August's employment numbers were revised upwards to 107,000, or three times the number estimated a month ago. Our forecast for the 2002 average unemployment rate is unchanged at 5.8% and we expect the unemployment rate to rise slightly in the 4th quarter with the weaker outlook.
- Interest rates have continued to plummet over the past four weeks, with the 10-year treasury setting a 45-year low and fixed 30-year mortgage rates setting a 36-year low. We have (again) revised our outlook for mortgage interest rates downward, with rates on 30-year fixed rate mortgages expected to average 6.0% in the 4th quarter. We have revised our forecast for 2003 as well with very low, but gradually rising rates over the year.
- Housing starts declined for three months in a row, coming in at 1.609 million units (SAAR) in August, but were still higher than we had previously thought. Thus, our forecast for 2002 was revised up to 1.66 million units, a 3.75% increase over 2001 starts. Housing starts in 2003 look to be about as high as in 2002.
- Sales of new homes set another record in August but sales of existing homes declined, coming in at just 5.28 million units (SAAR). Record low interest rates have helped fuel sales, and 2002 will be a record year with home sales of 6.50 million units. If low interest rates continue as we expect them to, 2003 could be an even better year for home sales.
- A refinancing tsunami is well underway in response to historically low mortgage rates. In recent weeks refis have risen to around 75% of mortgage applications. We have increased our projection of the refi share to 58% for 2002, falling to 54% for 2003 (due to the historical lows in interest rates and high model sensitivity to rates, we believe there is a high degree of statistical uncertainty associated with this estimate - a wide range of values are possible).
- Because of the high refinance activity we have once again increased our estimate of single-family mortgage originations. We are anticipating $2.2 trillion for 2002, an increase of 5.6% over 2001's record originations volume, and 2003 will be just as strong.
Source: Freddie Mac
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