A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Housing Reports a Bad Omen?

Mounting evidence of a slowdown in the U.S. housing market has led some forecasters to increase the chances that the world's largest economy will be limping into a recession next year.

"We have decided to raise the odds of a U.S. hard landing to 40 per cent from 25 per cent," National Bank Financial economists Clément Gignac and Stéfane Marion said in a note yesterday.

The catalyst, a pair of weak housing reports, led them to cut their 2007 U.S. gross domestic product forecast to 1.9 per cent from a projection of 2.4 per cent offered earlier this summer. They also lowered their target for personal consumption growth to 1.4 per cent from 2.3 per cent, a development that would "set the stage for a recession in U.S. profits."

In a further sign of trouble, an index that foreshadows turning points in the U.S. economy suggests things will get worse before they get better. The Economic Cycle Research Institute's weekly leading index annualized growth rate fell to a 179-week low yesterday, its worst level in more than three years.

"The growth rate has been falling steadily since January," said Anirvan Banerji, director of research at the independent forecasting group, based in New York. "That suggests that as far as the eye can see, the U.S. economy will keep slowing, at least through early 2007."

Mr. Banerji said it is too early to tell if the index is pointing to an actual recession, but would not rule out that possibility. "We are certainly not seeing any indication of a revival in economic growth."

One impact of the housing slowdown is that job creation in the construction industry -- which has been soaring in recent years -- has gone into reverse, he said.

An end to the housing boom will pressure home prices, leaving Americans feeling poorer and curbing consumer spending. "Until a few months ago, home prices were rising and people felt as if they were worth more and assumed that they were okay spending money," Mr. Banerji said.

"That cushion has now disappeared."

The first bearish housing report, released Thursday, showed that January new-home sales posted their largest drop since February while builders' inventories jumped to a record. A separate report from Wednesday showed sales of previously owned homes dropped to a 2½-year low and the inventory of unsold homes rose to a record high.

"In light of the swift buildup of the inventory of unsold homes, it is only a matter of time before prices decline at the national level," Mr. Gignac and Mr. Marion said. A "deterioration of household net worth, at a time when the sum of the household energy bill and financial obligations has risen to a record share of disposable income, will force consumers to rebuild their savings rate."

New and existing homes set sales records for five years as low mortgage rates and healthy employment created nearly ideal buying conditions. Interest rates, however, have risen in recent years as the U.S. Federal Reserve tried to keep inflation in check. After 17 straight increases, the Fed opted to leave interest rates unchanged at 5.25 per cent this month.

Paul McCulley, managing director and portfolio manager with California's Pacific Investment Management Co., which manages the world's largest bond fund, said the Fed will need to shift to a neutral or accommodative stance by next year.

A weak housing market will stifle economic growth over the next few quarters, cutting consumption and restraining job growth, Mr. McCulley told Reuters at the annual economic retreat hosted by the Kansas City Fed. At this point, he said, the property market is "crying uncle" and close to "screaming uncle."