Brooklyn's Progress
June/July 2006

BY JOEL L. NAROFF, PH.D., CHIEF ECONOMIST,
COMMERCE BANK

The economy has been humming along. First quarter growth was huge and jobs were plentiful. But suddenly, everything seemed to turn. The housing slowdown picked up steam. Businesses suddenly decided that maybe it was not a great idea to keep adding lots of workers. And inflation, which the Federal Reserve thought was tame, appeared to break out. So, are we in for a major economic retrenchment? And what will the Fed do?  Good questions.

The focus of attention this year has been on the housing market. So far, the bubbles have deflated fairly slowly, but the pace is accelerating. Housing starts are cratering. Home sales are turning downward and are at 2004, not 2005 levels. Although this may not be terrible, we are early in the cycle and we could see even sharper declines as we go through the year.

The softening housing market is affecting prices and, ultimately, that could lead to slower household spending. While nationally we don’t show huge price declines, there are many markets where the number of homes for sale is so large that significant price reductions will be necessary if owners are to move those properties. The price surge is over. How low prices go will depend upon the local market, but in some places there could be major price reductions.

Because households have been using their homes as ATM machines, the faltering housing market has some real implications. As equity soared, borrowings exploded. One look at the mortgage data and it is clear that the piggy bank is no longer being raided. Without that extra income, spending likely will be reduced.

The cutback in home borrowing might not be a major problem if job growth remained strong. It hasn’t. In May, firms added only 75,000 new employees, a very disappointing performance. The three-month average of 125,000 jobs is more indicative of a slow-growth economy, than the robust one we had been seeing.

With housing faltering and job growth slowing, are we in for a major economic retrenchment? Probably not. Businesses are investing and incomes are rising, although less rapidly. It’s an election year and we know what that means for government spending. And, with worldwide growth improving, our exporters are doing well. Just don’t expect anything close to the 5.3% growth we had in the first quarter.

Meanwhile, back at the Fed, chaos seems to be reigning. Hopes had been raised that the slowing economy would allow the Fed to stop raising rates. But Chairman Bernanke decided that the stories about inflation being tame were old hat. The new line is that inflation is a worry. Suddenly, the markets had no idea where the Fed was going – and one thing we know – markets hate uncertainty. The stock markets faltered.

What’s next? The Fed will meet at the end of June and it is just not clear if rates will be increased or a timeout called. The June jobs report, released in early July, should provide some insight into the true state of the job market. If you already fastened your seat belt, it might be good to tighten it a notch. 

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, America’s Most Convenient Bank, is a leading financial services retailer with nearly 400 convenient stores in New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, DC, Virginia and Southeast Florida. Commerce Bancorp (NYSE: CBH) is headquartered in Cherry Hill, NJ and has more than $40 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.