September increase in housing starts revives market fear of robust economy.

WASHINGTON -- Bond market fears that Federal Reserve credit-tightening efforts are not doing much to slow the economy mounted yesterday after the government reported a jump in September housing starts.

"The economy is strong. People just don't want to believe it," said Stan Carnes, chief portfolio strategist for Lehman Brothers.

Analysts said another increase in short-term rates at the Nov. 15 meeting of the Federal Open Market Committee is now a virtual certainty. There was also renewed speculation that Fed officials, who have already tightened credit five times this year, will continue pushing up rates into 1995.

Normally when the Fed raises rates, the housing sector is the first to show the impact by slowing down as consumers react to higher financing costs. The Mortgage Bankers Association yesterday said the average fixed-rate. mortgage in the week ending Oct. 14 hit 9%, a three-year high.

However, the Commerce Department said yesterday that housing starts surged 4.4% last month to a seasonally adjusted annual rate of 1.53 million units, the highest level this year.

Starts of single-family homes shot up 6.1% to 1.25 million, more than wiping out an August downturn and marking the highest level since March, shortly after the Fed began raising rates. The government also said builders took out permits for new housing at an annual rate of 1.44 million units, the most since last December.

"The economy's doing fine, and the Fed is behind the curve," said Neal Soss, co-founder of Soss & Cotton Enterprises, a private hedge fund in New York. "There is precious litfie evidence of any deceleration."

Fed policymakers have said that to keep inflation under control, they do not want to see the economy growing more than 2.5% a year. But analysts yesterday said that goal appears increasingly elusive and that growth is likely to be in the range of 3% or higher during the second half of the year -- a slowdown compared to the first half of the year but not enough to keep the central bank from turning the screws.

The housing report follows news of healthy retail sales in September and surprisingly strong business inventories in August that suggested manufacturers und retailers remain optimistic about future sales.

Deputy Treasury Secretary Frank Newman sought to play down fears of an overheating economy, telling members of The Exchequer Club that "there's been nothing to show any drastic increase in inflation."

But most analysts continue to expect FOMC members meeting Nov. 15 will raise the federal funds rate to 5.25% from 4.75% and the discount rate to 4.5% from 4%. And the bias in Fed policymaking is likely to remain tilted toward further credittightening, economists said.

"For all practical purposes the bond market is priced to a funds rate of 5.25% and rising," said Soss. "I don't think anyone is going to approach the November tightening as the last one." The yield on the Treasury's 30-year bond yesterday hit 8%.

Further agitating the market yesterday, the Federal Reserve Bank of Philadelphia said its business index jumped to 33.2 in October from 14.8 in September. The bank also said its price index shot up from 40.4 to 53.6, the highest reading since February 1989.

The housing starts figures are notoriously volatile, and some analysts suggested they could be overstating the industry's strength. Sales of existing homes, a broader gauge of buying activity, have been sliding since December, and mortgage bankers report loan applications are down by nearly two-thirds compared to a year ago.

David Seiders, chief economist for the National Association of Home Builders, said builders he has met around the country are once again being enticed with loan offers from cash-rich banks and thrifts. Seiders said he suspects builders are overestimating demand and that he still expects the pace of building to dip in the last three months of the year.

Still, analysts called the housing figures impressive. David Lereah, chief economist for the Mortgage Bankers Association, said interest rates are still low compared to what they were in past years and that home buyers have been able to shield themselves with adjustable-rate mortgages.

In addition, analysts said gains in household income from an improving job market appear to be outweighing the cost of higher interest rates. "It's a tug-of-war between the economy and higher rates," said Lereah.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER