Housing production will be constrained somewhat by declining affordability and labor shortage, but our forecast calls for a continuation of a relatively strong level of 1.2 million housing starts in 2018
By JAMES DOTI, Ph.D.
Although cumulative growth during the current expansion has been weak when compared to other recoveries, it is now the second longest expansion on record. The critical question now is whether the expansion can endure in the face of full employment and falling productivity.
Historically, three economic trends have consistently signaled the end of expansions and onset of recession. Those signals include a negative interest rate spread (short-term interest rates are higher than long-term rates), a sharp drop in housing starts, and rising levels of private debt. With none of these recessionary signals in sight, we are confident that the expansion will continue through 2018. The rate of real GDP growth, however, is forecasted to decline slightly from 2.3 percent estimated for 2017 to 2.2 percent in 2018.
We believe the Federal Reserve Board will follow through on its earlier intention to raise the fed funds rate before the end of this year. Then we expect two more increases in 2018. The 90- day Treasury bill closely parallels that rate and is forecasted to rise from 1.2 percent to 1.8 percent by year-end 2018. The 10-year treasury bond is also forecasted to increase about 60 basis points. With short- and long-term rates increasing in lock step, the interest rate spread is expected to hold steady at 1.1 percent.
Although this is a decline from the 1.8 percent spread at the beginning of last year, it’s not enough to signal an imminent recession. Although housing production will be constrained somewhat by declining affordability and limited availability of construction workers, our forecast calls for a continuation of a relatively strong level of 1.2 million housing starts in 2018. This roughly matches the cyclical highs reached in 2017.
Private debt as a percentage of real GDP has held constant near 150 percent since 2011. In 2018, we see debt increasing. While this increase will not be enough to point to recession, coupled with continuing Fed tightening, it is expected to restrain consumer and investment spending. And while the global economy is probably in its best overall shape since the recovery began, China’s growth will be constrained as a result of its increasing private debt. China’s private debt as a percentage has increased sharply from 115 percent in 2008 to an estimated 210 percent in 2017.
A drop in housing starts is almost always preceded by increases in the supply of unsold units as well as greater pessimism on the part of leaders in the housing industry. Recent trends in these series could hardly be more positive. The supply of unsold inventory at current sales trends is down to four months, while the National Association of Home Builders’ (NAHB) housing market index is near all-time highs.
After experiencing sharper job losses and higher unemployment than the U.S. during the Great Recession, California caught up by the end of 2013 and has since outpaced the nation in job growth. But these macro trends mask a number of structural changes in the California economy. In comparison to the U.S., California’s manufacturing sector has hardly grown. The state’s weakness in this sector, however, has been more than offset by very strong relative growth in construction and information services jobs. These sharp swings in the pattern of job creation point to California’s shedding of lower value-added manufacturing jobs to higher value-added jobs in information services. The swings also suggest that California is becoming increasingly dependent on the cyclical and volatile construction sector.
As a result, we are forecasting a slight decline in California employment growth from 1.7 percent in 2017 to 1.5 percent in 2018. California’s manufacturing sector is certain to show additional weakening in 2018. Not only is the manufacturing sector declining nationally as jobs move offshore, but it will be increasingly difficult for California’s manufacturing industry to compete against lower-cost regions in the U.S.
The supply of unsold resale homes is near historic lows, which suggests a future uptick in construction activity. Given rising mortgage rates, however, housing affordability is forecasted to continue its downward slide. These countervailing indicators lead our forecast to call for solid growth in residential permits in 2018, but at a slower rate than 2017’s pace.
Proposals to gut NAFTA have the potential to sharply cut into California’s economic growth. This, at a time when the state’s ability to create jobs is already on the wane. Since NAFTA’s creation in 1995, California’s exports to Mexico increased from $6.5 billion to $25.3 billion in 2016. Imports increased even faster, from $9.0 to $46.3 billion. Moving these imports from Mexico to market creates thousands of jobs in California.
The full report is available at http://www.chapman.edu.
James L. Doti, Ph.D., has served as Chapman University’s president since 1991. He is President of Emeritus, Donald Bren Distinguished Chair of Business and Economics. He may be reached at firstname.lastname@example.org.