Hurricane Rita battered the Gulf coast just three short weeks after Katrina, and while no where as severe nor as close to major population centers, it wreaked a fair amount of destruction and undid some of the reconstruction in the New Orleans area. The double whammy of two substantial storms hitting nearly the same coastline has severe repercussions for economic growth and the labor market.

The clearest sign of their effect was in the Department of Labor's report for the month of September. Payroll employment outside of farms fell for the first time since May 2003, down by 35,000. Over the prior year, the average monthly job gain had been 194,000, thus the storms had wiped out a net of about 200,000 jobs last month. The biggest losses were in retail, which dropped 88,000, and leisure and hospitality, down 80,000 as hotel and casino jobs were washed away. Manufacturing continued to shed jobs, losing another 27,000 in September. On the positive side, construction jobs were up once again, as single-family construction remains on a record-setting pace in 2005.

Shuttered businesses, lost jobs, import-export delays through the New Orleans area (the fifth busiest port in the U.S.), and higher energy costs will reduce GDP growth by about one-half of a percentage point (annualized rate) in the final months of 2005, to an estimated 3.5 percent growth rate. The federal monies that will go to reconstruction will have a significant stimulative effect by early next year, adding about 0.5 percent (annual rate) to economic growth over the first half of 2006. While crude oil prices may gradually moderate in coming months, there are reports of natural gas shortages looming as the nation approaches the winter heating season, raising the specter of higher heating bills for many northern households.

With the employment report not as bad as some had feared, economic growth likely to accelerate in 2006, and the specter of higher energy costs adding to inflationary concerns, it is likely that the Federal Reserve will continue to boost the federal funds target at quarter-point increments, timed with Federal Open Market Committee (FOMC) meetings. Thus, barring any further shocks that may derail economic activity, the Federal Reserve may well boost the target at both its November 3 and December 13 meetings, placing the federal funds rate at 4.25 percent by year-end.

Acceleration in U.S. growth and rising energy costs will likely translate into higher long-term rates as well. Thus, mortgage rates, from 1-year ARMs to hybrids to 15-year and 30-year fixed-rate loans, are projected to rise gradually over the next year. For example, 30-year fixed-rate loans are projected to rise from an average of 5.8 percent in September 2005 to 6.4 percent by December 2006.

Home sales will hit a record in 2005, but higher mortgage rates will ease overall demand next year, resulting in less sales and a significant slowdown in home-value appreciation. The reconstruction efforts will place additional upward pressure on construction material costs. Since construction materials account for about one-third of the cost of a new home, increases in costs for lumber, cement, gypsum board and other materials of only five percent to 10 percent could add two percent to three percent to new home costs over the next year. Refinance will slow further and account for only about one-third of new loan production in 2006, the lowest share since 2000(?). Single-family originations will be off by about five percent in 2006 from this year's volume as a result; purchase-money lending should remain robust, as a dip in home sales will be largely offset by higher home values, thereby maintaining home-purchase originations.

Published: October 13, 2005

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