October 2007

Moderate Economic Growth, Subsiding Inflation

Data released over the past few weeks suggest that overall economic growth remains moderate and inflationary pressures are likely to continue to subside. Downside risks to both household and business spending appear somewhat less troubling.

Economy Grew 3.9 percent in Q3
Real GDP grew 3.9 percent in the third quarter, up from 3.8 percent in the second quarter. Almost every major category posted solid gains: consumption expenditures, nonresidential investment, inventories, government purchases and net exports. Residential construction remained a drag to growth, chopping real GDP growth in Q3 by more than one percentage point (Chart 1).

Housing Market Continues to Deteriorate
Housing starts slumped another 10.2 percent to 1.19 million annualized units in September, led by a 34 percent plunge in multifamily starts. Housing permits fell 7.3 percent and have dropped 25 percent since the beginning of this year. Both housing permits and starts were lower than their levels a decade ago.

New-home sales came in at 0.77 million annualized units in September, up 4.8 percent from August. However, there were large downward revisions to prior months, and new-home sales were 23 percent lower in September than a year ago. Existing-home sales plunged 8 percent to 5 million annualized units in September (Chart 2). Inventories of unsold homes are now 8.3 and 10.5 times the current monthly sales pace for new and existing homes, respectively. The median existing-home price was 4.2 percent lower than a year ago.

Payroll Employment Rebounded in September
Nonfarm payroll employment rebounded in September with net job gains of 110,000. Moreover, employment growth in August was substantially revised from a job loss of 4,000 to a gain of 89,000, largely due to upward revisions to growth in government jobs (Chart 3). Manufacturing employment continued to decline in September. The unemployment rate edged up to 4.7 percent as more people came back to the labor force than the number of jobs being created.

Credit Conditions Remain Strained
Conditions in financial markets have shown some signs of improvement in the past few weeks, although considerable strains remain. Treasury bill rates partially rebounded from their lows in August. While the gap between short-term commercial paper and Treasury bill rates has narrowed to around 130 basis points, risk aversion remains notably high.

Primary business borrowers have experienced little net change in their borrowing costs. Higher spreads have been offset by lower Treasury yields, which have been influenced by both a flight to safety and actual and expected FOMC rate cuts. The corporate junk bond rate rose moderately but remains at a relatively low level compared with its history. Jumbo mortgage rates declined during the past few weeks, and the low-risk conforming mortgage rates were almost unchanged.

Long-Term Capital Flows Turned Negative in August
Reflecting the turmoil surrounding mortgage and asset-backed securities, net Treasury International Capital flows plunged to a value of –$163 billion in August, and the net foreign purchases of U.S. long-term securities dropped $88.8 billion to –$69.3 billion. The last time the long-term capital flows went negative was in August 1998, another period of crisis in global financial markets. The diminished foreign appetite for long-term U.S. financial assets is alarming and may weigh heavily on credit availability as well as the value of the U.S. dollar.

Consumer Inflation Continued to Decelerate
Inflationary pressures continue to ease. The core Consumer Price Index (CPI), rose a modest 0.2 percent in September, essentially unchanged from August. The overall CPI increased 0.3 percent in September, boosted by rising food and energy prices. The 12-month core CPI inflation rate now stands at 2.1 percent, unchanged from August.

The overall Personal Consumption Expenditures (PCE) price index edged down by 0.1 percent in August, the first monthly decline since October 2006. For six straight months, the core index edged up by a modest 0.1 percent, suggesting moderating inflationary pressures. Over the past 12 months, both the overall and the core PCE price indexes have risen by 1.8 percent (Chart 4).

—Tao Wu

About the Author Wu is a senior economist in the Research Department at the Federal Reserve Bank of Dallas.