The effect of Hurricane Katrina will be felt in the battered Gulf region for quite some time to come. The effect on the national economy has also been quite immediate through lost output from the Gulf region, decline in wage income from workers who have lost their jobs, spike in energy costs, and disruption to import-export trade flows through New Orleans and other near-by ports.
The shock to the economy is expected to cut 0.5 percent to perhaps as much as 0.75 percent (annual rate) from second-half real GDP growth, reducing economic growth in the latter half of the year to about 3.5 percent, annualized. The net employment loss will also be substantial, about a 200,000 to 300,000 net shortfall this month directly attributable to the disaster.
Thus, the labor market report for September (based on the Labor Department’s survey to be conducted the week of September 12), which otherwise would probably have shown a healthy employment gain, will likely show little change or a drop of as much as 100,000 (or more) when it is released on October 7, the first decline in payroll employment since May 2003.
Recovery efforts were slow the first few days but appear to have gained substantial momentum. The federal monies that will go to reconstruction and the lower interest rates that have evolved from the calamity will stimulate economic growth next year. Thus, economic growth is likely to accelerate in the first half of 2006 to make up for the lost economic activity the U.S. will experience over the next few months. A drop in energy costs over the next few months will further support recovery efforts and national growth.
Pre-Katrina, the Federal Reserve had implied that it was likely to continue boosting the federal funds target at quarter-point increments, timed with Federal Open Market Committee (FOMC) meetings.
However, it has become more likely that the Fed will take a pause to assess the fragility of the economy and to support the credit needs of recovery efforts. Any pause may well be temporary; with two more FOMC meetings scheduled for the autumn, if the reconstruction efforts are going well we expect the federal funds target may be at four percent by year-end.
The weaker near-term growth outlook and greater likelihood of Fed "pause" has brought long-term yields, including mortgage rates, lower once again. It appears likely that 30-year fixed-rate loans will carry interest rates below six percent for the balance of the year. Stronger economic activity and additional moves by the Fed to swing monetary policy to a "neutral" stance (that is, further short-term rate hikes in 2006) will push mortgage rates higher in 2006.
While lower near-term mortgage rates will continue to fuel nation-wide housing demand, the reconstruction efforts will place additional upward pressure on construction material costs. The most immediate effects will be on plywood and roofing tiles, as many homeowners make repairs in the broader Gulf region. 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 5 percent to 10 percent could add two percent to three percent to new home costs in coming months, supporting existing home values.
The net effect (lower interest rates but higher construction material costs) on overall construction is likely to add to new starts in 2006 and existing home sales, relative to what they would have been. Thus, mortgage originations will be slightly greater too, compared to our pre-Katrina projection.
