Economic Review and Outlook
April 2007
A Tense Time for Housing and The Economy
The first signs of real
trouble for housing and the economy during the current expansion emerged in the
first quarter of 2007 as several sub-prime lenders reported unmanageable
delinquencies and defaults.
With almost every major mortgage lender involved in sub-prime lending, the
extent of the damage has been difficult to assess. Investors had suspected some
sub-prime problems, but were caught off-guard by the poor timing of the news
following recession talk by former Fed Chairman Greenspan and credit tightening
discussions by the Chinese. As a result, investors were forced to discount the
risks to the economy – global stock markets fell by 5% or more before regaining
some lost ground.
The path ahead for the economy and its implications for financial markets
dominate investor concerns. Housing worries will remain high until the spring
selling season passes. While activity and prices are likely to be soft, a
housing collapse is highly unlikely.
Economic growth will reach its low point for the year by summer; but a recession
is doubtful unless there is a sudden change in the currently firm employment
picture. Corporate investment and commercial construction have offset the
weakness in housing and seem likely to continue, as indicated by the gap between
cost of capital and return on capital.
Globally, the outlook for growth in Europe and Asia has softened. We expect a
downshift in the 2nd quarter to develop overseas as well.
Meanwhile, financial markets have been resilient as optimism remains relatively
high. This seems reasonable, given the continued favorable trends for inflation
and positive comments from the Fed. Bernanke has countered the negative rhetoric
from Greenspan with cautious optimism.
While the markets likely will shrug off this spate of bad news, the upside will
be limited until a better picture for housing emerges.
We remain optimistic.