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U.S.: So Far, The Interest Rate Bite Is More Like A Nibble


Business Outlook: U.S. Economy

U.S.: So Far, the Interest Rate Bite Is More Like a Nibble

Housing is topping out, not sinking, and other sectors are picking up

Are higher interest rates starting to pinch? If they are, the latest round of Federal Reserve tightening may soon end. So far, two key areas are feeling a twinge: housing and the stock market. Both have been leaders in the economy's soaring pace of late because they have supplied some of the jet fuel that has powered consumer spending. And both are generally expected to lead any coming slowdown.

But it might not be that simple. To be sure, a cooldown in consumer buying and homebuilding is a prerequisite for an overall downshift in economic growth that will allow the Fed to move to the sidelines. But right now, other sectors in the economy are starting to contribute more to growth than they have been. Exports are picking up sharply, which means that the trade deficit will be less of a drag in coming quarters. And the export revival is lifting manufacturing output and boosting the need to build inventories. Factory orders for durable goods, for example, although down 1.3% in September, surged at an annual rate of 21.8% for the quarter, the strongest advance in six years.

What's more, as long as growth in jobs and incomes remains solid, as most indicators suggest, any slowdown in consumer spending and homebuilding will be limited. Consumer confidence fell for the fourth month in a row in October, but the level remains high, considering recent stock market volatility and higher mortgage rates.

Moreover, keep in mind that for the stock market to exert a significant slowing force on overall growth, the 9% falloff in stock prices since July will have to be sustained--and probably even deepened. For that to happen, the Fed will have to remain an imposing figure on Wall Street for months to come, or the markets may simply rebound only to refuel growth.

CLEARLY, THE HOUSING SECTOR is topping out, reflecting the sharp jump in mortgage rates since April, but it is far from sinking (charts). Sales of existing single-family homes fell for the third consecutive month in September, to an annual rate of 5.13 million, but Hurricane Floyd may have been a factor. Also, the decline is from a record 5.63 million pace in June, and the September reading is still ahead of the record level for all of last year. This year's pace will top that.

Nevertheless, the delayed effects of costlier mortgages are now showing up in the sales data, which are based on actual closings that can take a month or two to complete. Thirty-year fixed mortgage rates surged from just under 6.8% in mid-April to 8.1% in mid-August, and they are still hovering around 8%.

They are likely to remain there, given the sharp rise in Treasury bond yields in late October. In only the past month, since late September, the yield on the 30-year benchmark bond has jumped from 5.97% to 6.38% on Oct. 26. At the same time, the 10-year bond, whose path more closely foreshadows that of fixed mortgage rates, has risen a bit more, from 5.77% to 6.24%. Treasury bond yields are the highest in two years, as bond investors stew about future inflation, a possible Fed rate hike on Nov. 16, and now, a possible November rate hike in Europe.

The effects show up in mortgage applications to buy a home, which are down 15% from their April peak. Refinancing activity peaked much earlier. It has plunged 80% since the end of last year. So far this year, though, the impact of less refi activity on consumer spending appears to have been small.

HIGHER FIXED MORTGAGE RATES alone, however, are unlikely to cause major damage to homebuying. First of all, fixed rates, even at 8%, are not high by standards of recent years. Thirty-year rates have averaged 7.7% during this expansion. In 1994, they had to rise to considerably more than 9% before exacting a significant toll on home demand.

More homebuyers are simply switching to adjustable-rate loans when fixed rates rise. Since the beginning of the year, applications for fixed-rate mortgages have been cut in half, but those for adjustable-rate loans, which accounted for 30% of new mortgages in August, have doubled, according to the Mortgage Bankers Association of America. A year ago, adjustable rate loans were only 8% of new mortgages.

Also, housing-market conditions remain tight. The seasonally adjusted months' supply of unsold existing homes is holding close to a record low level in relation to the recent pace of sales, and the same is true in the new home market. Amid such conditions, it's not surprising that prices of construction materials are increasing--and at a faster pace than intermediate materials generally. Also, the unemployment rate in construction is the lowest in 2 1/2 decades.

Although housing starts are down from their peak levels of late last year, these conditions suggest continued firmness in home prices and incentives for builders to put up new homes. In fact, some of the dip in starts in recent months may well reflect spot shortages of building materials and workers rather than weaker demand. So while homebuilding is unlikely to add anything to economic growth in the second half, neither is it likely to be a big drag.

HIGHER INTEREST RATES and the stock market's recent volatility appear to be affecting consumers' attitudes, but not by a degree that could foreshadow a any big pullback in buying. Some Y2K concerns may also be coloring the way households see the immediate future.

The Conference Board's index of consumer confidence dipped again in October, to 130.1. That's down nearly nine points from June, but the June reading was a three-decade high. The Board notes that October confidence remains higher than it was this time last year, and that last October's reading preceded a very strong holiday shopping season.

It's not surprising that stock prices and consumer confidence are more tightly related these days. Nearly half of all households--48%--own stocks either directly or through mutual funds, according to a new study by the Investment Company Institute and the Securities Industry Assn. That's up from about 32% in 1989.

As you might expect, the recent dip in optimism shows up primarily in consumer expectations for the six months ahead. Consumers' assessment of their present conditions, while down slightly, remains extremely high, buoyed by rising incomes, low inflation, and the lowest jobless rate in 29 years (chart).

To be sure, the Fed will take note of the recent weakening in housing and stock prices when it meets on Nov. 16 to decide on interest rates. But in the end, any slowdown in overall demand will have to be great enough to take pressure off the labor markets--the Fed's No. 1 concern. So far, there is no sign of that, especially since higher rates have left little in the way of teeth marks.By James C. Cooper & Kathleen MadiganReturn to top


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