Here’s why this morning’s housing starts matter

Joe Brusuelas is the Chief Economist at McGladrey. This article originally appeared on his excellent blog.  You can follow Joe on Tumblr and Twitter.

The 20.2 percent increase in April housing starts to 1.135 million at an annualized pace is the first step in what will be a multi-year process to get back to full utilization of resources in the housing sector. This data is also indicative of a much stronger start to the current quarter.

A tightening labor market, rising wages and inflation-adjusted income are all supportive of improved demand for shelter and housing-related services. Our current estimate of 2.5 percent increase in GDP is consistent with this data and we anticipate that the May and June spending and residential investment data will support an upward revision to that estimate. While this data in the early trading session kicked off a sharp move higher in the U.S. ten-year Treasury yield, it is not compelling enough for the Federal Reserve to raise rates at the June meeting. Policymakers instead are more likely to consider a September rate increase.

Forward-looking building permits imply an increase in starts toward 1.143 million at an annualized pace. That meshes well with industry reports of improvement in residential investment and sales. There are about 853,000 homes under construction currently, of which 363,000 are single family residences and 490,000 are multifamily dwellings. This translates to increases of 14.8 percent, 7.1 percent and 21.3 percent on a year-ago basis, respectively.

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The data in part reflects current preferences of the 25- to 34-year-old cohort for renting. While this will not provide much comfort to policymakers at the central bank who want to see a strong increase in single family starts, it will provide a much needed boost to growth after what will likely prove to be a contraction in economic output to start the year.

One of the two missing ingredients in the soggy U.S. expansionary cycle has been residential investment (the other is fixed business investment) Residential investment accounted for about 3.1 percent of GDP growth through the end of the fourth quarter last year, compared with 6.2 percent at the peak of the housing bubble in 2005. New starts, home improvement and brokers’ commissions, which feed into the calculation of GDP, all have steadily improved from the trough in 2008-2009, and at the end of last year had climbed to cyclical highs of $177.9 billion, $246.9 billion and $137 billion, respectively. While a combination of tighter lending, regulation and soft demand will make a return to form unlikely, an improved labor market, the composition of hiring (high-wage versus low-wage job creation), rising household formation and historically low rates should all support a move back toward 4 percent in this business cycle.

The key to an improved outlook is the employment and wage outlook for those aged 25- to 34-years-old. The employment-to-population ratio of this cohort has improved to a cyclical peak of 76.8 percent, while the share of the total labor force of that group has surpassed its pre-cyclical peak of 20.6 percent. Moreover, once one looks into the changing demographic profile of the economy and the workforce, there is certainly cause for near- and medium-term optimism.