ECONOMIC WEEKLY. Housing Has Peaked. New single-family homes sold (SAAR) CONTENTS ECONOMICS. Should We Worry? JANUARY 18, 2019

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1 JANUARY 18, 2019 ECONOMIC WEEKLY Housing Has Peaked. Should We Worry? Residential investment was one of last year s bigger disappointments. Sales slumped as mortgage rates rose and residential investment turned negative. At the December FOMC meeting, weak housing and fear of a further decline topped the list of the Fed s three biggest economic risks. Housing is a leading indicator and, because home sales peaked in November 2017, it is one of the few already flashing a recession warning. That said, housing s influence on economic growth is much diminished. And, the lead time between the cyclical peak in housing and the start of recessions has varied from four years in 1986 to 15 months in 1979, so it s not a very useful warning on its own. (The lead time before the recession was three years and five months.) This is particularly true in the current expansion because housing s influence on economic growth is far smaller than in past economic cycles. New single-family homes sold (SAAR) 1600k 1400k CONTENTS Housing Has Peaked. Should We Worry? ECONOMICS Chris Low, Chief Economist chris.low@ftnfinancial.com page 1 The Week Ahead page 6 This Week s Numbers page 6 Rebecca Kooshak, Economic Analyst rebecca.kooshak@ftnfinancial.com 1200k 1000k 800k 600k 400k 200k '85 '86 '87 '89 '90 '92 '93 '94 '96 '97 '99 '00 '02 '03 '04 '06 '07 '09 '10 '11 '13 '14 '16 '17 Source: Census Bureau, National Bureau of Economic Research 0k House prices are falling, too. House price appreciation recovered nicely from the first-ever (at least, as far as the data go) decline before slowing to about 5% year-on-year from 2015 through Last year s first year-on-year decline was in May and the 6-month average year-on-year growth rate turned negative in September. Falling home prices are further evidence housing has peaked for the cycle. Disclosures are on the last page of this report. FTNFINANCIAL.COM

2 ECONOMIC WEEKLY JANUARY 18, % 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% Median new home price -10.0% year-over-year % change -15.0% 6-mo mvg avg -20.0% Source: National Bureau of Economic Research, Census Bureau, FTN Financial Starts still rising, but investment petering out Existing home sales also peaked in November 2017, but new home sales are more important from a GDP standpoint. People spend money on home improvements when existing homes turn over, but existing homes contribution to GDP pales in comparison to the contribution from new home sales where every dollar is new investment. Housing starts appear to be cresting, though there is not yet a clear cyclical peak. In May, the 1.329m annual rate of single family starts we look at single-family starts because the series is more comparable to new home sales was 25.4% lower than the average during the expansion, and 6.6% lower than the average in the expansion. There s little doubt that while much tighter restrictions on mortgage lending have made housing finance safer, they have also restricted GDP growth in this cycle. 1900k 1700k 1500k Single Family Housing starts (SAAR) 1300k 1100k 900k 700k 500k 300k Source: Census Bureau, National Bureau of Economic Research The next chart shows outstanding mortgage debt as a percent of GDP. Mortgage debt has grown since early 2015, but because the growth rate is slower than GDP growth, the ratio of mortgage debt to personal income, 58.2%, is the lowest since late 2001 and falling. Given the relative stickiness of prices and unwillingness or inability by lenders to increase LTVs, we expect this ratio will continue to fall, likely to 50% or so eventually. It should accelerate lower after the next recession. Page 2 of 10

3 ECONOMIC WEEKLY JANUARY 18, % 85.0% Household mortgage lending as % of personal income (SAAR, BIl $) 75.0% 65.0% 55.0% 45.0% 35.0% '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 Source: Federal Reserve Board, Census Bureau, National Bureau of Economic Research, Bureau of Economic Analysis The WSJ reports brisk growth in home equity lending, and we have met some of the lenders from states like Florida, where home prices have risen 54% in five years, who are underwriting these loans and report growth rates of % annually. Bear in mind, however, this growth is from an extraordinarily low base, as HELOC lending fell to zero in the financial crisis. Lending standards are strict, even at the institutions reporting the fastest loan growth, with LTVs of combined first and second mortgage principal capped at 80% of home values compared to LTVs of 125% before the crisis and, despite growth in HELOC underwriting, outstanding home equity credit and credit lines continues to fall, according to Federal Reserve data. In other words, Americans are paying down and closing HELOCs faster than they are opening them. Housing and GDP Changes in mortgage finance along with demographic shifts have significantly reduced housing s influence on GDP. The chart below shows the contribution to GDP from residential investment. Believe it or not, housing was so overbuilt by 2005, the contribution was negative from the first quarter of 2006 until the recession began in the fourth quarter of Indeed, it was so deeply negative by mid-2006, withback-to-back contributions to GDP of -1.3%, the contribution of residential investment to GDP through the entire expansion was -0.1% despite the housing bubble. As a result, housing s average contribution in the current expansion, +0.1%, is bigger on this basis. 1.0% Residential investment contribution to real GDP growth 0.5% 0.0% -0.5% -1.0% 4-qtr mvg avg -1.5% '85 '87 '88 '89 '90 '92 '93 '94 '95 '97 '98 '99 '00 '02 '03 '04 '05 '07 '08 '09 '10 '12 '13 '14 '15 '17 '18 Source: National Bureau of Economic Research, Bureau of Economic Analysis Page 3 of 10

4 ECONOMIC WEEKLY JANUARY 18, 2019 If residential investment were the only way housing influenced GDP, we would have to conclude housing is indeed contributing more in the current cycle than the last. But, not surprisingly, there are other factors to consider. Income from residential construction estimated from residential construction payrolls and average weekly earnings of construction workers is down at least 10% from its 2006 peak. 1 At least construction income is up. The other significant source of GDP from housing, mortgage equity withdrawal, or MEW, is still falling. The chart below shows the contribution to real GDP from residential investment and MEW if equity withdrawal had been spent in the year homeowners opened their credit lines. 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% Res investment + MEW Contribution to GDP growth Recessions 4 QTR moving average -5.0% Source: Haver Analytics and the Bureau of Economic Analysis Back in 2005, when Alan Greenspan and James Kennedy suggested mortgage equity withdrawal was contributing as much as 2% to annual GDP growth, economists were incredulous. The collapse of mortgage credit and subsequent collapse of GDP bore them out, however. Even allowing that some portion of home equity lines were never drawn upon, consumer spending power benefited enormously from During the peak years of the housing boom, housing contributed 2% to GDP. In the mid- 90s, it contributed as much as 1%. Since the financial crisis, however, it has been a constant drag, once as much as -2%, now about -1%. Bottom line: One more (small) reason to worry Housing and autos both appear to have peaked for the cycle, suggesting fed funds rate increases to date are doing what they are supposed to do, increasing financing costs and constricting spending despite a generous tax cut last year. Both autos and housing are leading indicators. Based on historical lead times, a recession is likely to begin sometime between mid-2020 and late Unfortunately, it does not get any more precise than that. Housing and autos are important to GDP because debt-finance allows spending to carry through occasional periods of weak income growth. By the same token, the loss of these big-ticket growth engines in the late cycle makes GDP vulnerable. Between the two, housing gets far more attention from economists, including those at the Fed, because it has played an outsized role in driving economic growth in recent cycles. People take out car loans to buy cars. They take out mortgage loans, especially HELOCs, to invest in home improvements, pay down credit cards, and buy everything from cars and vacations to college educations. 1 The BLS reports the number of residential construction workers, but average hourly and weekly earnings are only disaggregated down to total construction workers. Residential contractors make less than commercial contractors, and the share of residential contractors fell from 13% to 11% of the total since the housing boom turned to a bust 12 years ago. As a result, residential construction workers income is likely down more than the 10% change we calculated. Page 4 of 10

5 ECONOMIC WEEKLY JANUARY 18, 2019 Because mortgage borrowing relative to GDP has fallen throughout this expansion, however, it is not nearly as important to growth as it was in any prior cycle since at least the 1970s. (And likely the 1930s. Unfortunately, housing data don t go back that far.) The contribution to GDP from residential investment and mortgage equity withdrawal is unlikely to change by more than a tenth or two between now and the next recession. This is the upside of the housing and mortgage crash. Our economy is less interest rate sensitive, and thus less vulnerable to Federal Reserve policy errors, than it used to be. The downside, as the Fed learned in the early years of the recovery, when GDP does fall, it is a lot more difficult to set it back on a path of sustainable growth without the usual contribution from robust home sales. Chris Low, Chief Economist Page 5 of 10

6 THE WEEK AHEAD JANUARY 18, 2019 The Week Ahead This Week s Numbers CONSENSUS PRIOR HIGH LOW MEDIAN FTN Monday, January 21 Martin Luther King Day Tuesday, January 22 Existing Home Sales MoM - Dec 1.9% 0.6% -3.2% -0.9% -1.0% Existing Home Sales - Dec 5.32m 5.35m 5.15m 5.27m 5.27m May be delayed Advance Goods Trade Balance - Nov -$77.2b -$73.1b -$78.0b -$76.1b $77.0b May be delayed Wholesale Inventories MoM - Nov P 0.8% 1.0% -0.2% 0.5% 0.4% May be delayed New Home Sales - Nov 544k 622k 535k 567k 560k May be delayed New Home Sales MoM - Nov -8.9% 14.3% -1.7% 4.2% 2.9% May be delayed Construction Spending MoM - Nov -0.1% 1.2% -0.5% 0.2% 0.1% May be delayed Factory Orders - Nov -2.1% 1.1% -1.2% 0.3% 0.2% May be delayed Trade Balance - Nov -$55.5b -$51.6b -$57.0b -$54.0b -$55.0b May be delayed Monthly Budget Statement - Dec -$204.9b $20.0b -$32.7b -$10.0b $5.0b May be delayed Retail Sales Advance MoM - Dec 0.2% 1.2% -0.2% 0.1% 0.2% May be delayed Retail Sales Ex Auto MoM - Dec 0.2% 0.8% -0.3% 0.0% 0.0% May be delayed Retail Sales Ex Auto and Gas - Dec 0.5% 0.7% 0.1% 0.4% 0.3% May be delayed Retail Sales Control Group - Dec 0.9% 0.8% 0.1% 0.4% 0.4% May be delayed Business Inventories - Nov 0.6% 0.5% 0.0% 0.3% 0.4% May be delayed Housing Starts - Dec 1256k 1309k 1200k 1252k 1253k May be delayed Building Permits - Dec 1328k 1335k 1215k 1290k 1301k May be delayed Housing Starts MoM - Dec 3.2% 3.8% -4.5% -0.5% -0.2% May be delayed Building Permits MoM - Dec 5.0% 0.5% -8.4% -2.9% -2.0% Wednesday, January 23 FHFA House Price Index MoM - Nov 0.3% 0.0% May be delayed Wholesale Inventories MoM - Nov F 1.0% -0.2% 0.5% 0.5% Thursday, January 24 Leading Index - Dec 0.2% 0.2% -0.1% -0.1% -0.1% Friday, January 25 Durable Goods Orders - Dec P -1.0% May be delayed Durables Ex Transportation - Dec P -0.5% May be delayed Cap Goods Orders Nondef Ex Air - Dec P -0.3% May be delayed Cap Goods Ship Nondef Ex Air - Dec P 0.1% May be delayed New Home Sales - Dec May be delayed New Home Sales MoM - Dec Review The week s biggest market moves in 10-year Treasuries came after The WSJ reported the US may be willing to lift tariffs in order to secure a deal with China. The proposal reportedly came from Treasury Secretary Mnuchin and if past performance is any indication of future results which of course, it s not Mnuchin s China negotiations are unlikely to result in an actual deal. Bloomberg News reported this morning that China is offering to increase US imports by a combined total of $1tn annually, which would result in a trade balance of zero between the two countries by The deal reportedly was offered a month ago by the Chinese, but US negotiators asked China to agree to balance the trade deficit within two years. Intellectual property theft still remains an issue. Data was light this week and little progress was made on reaching an agreement reopening shuttered government departments. But the Fed s Beige Book provided some information on the direction of the economy and holiday retail sales. Page 6 of 10

7 THE WEEK AHEAD JANUARY 18, 2019 The Beige Book showed indications of a late cycle, with eight of 12 districts reporting moderate growth and four reporting slower or level economic activity. (In particular, Boston, New York, Philadelphia, and Kansas City showed signs of slowing.) Non-auto retail sales on a national basis increased moderately, with some districts reporting robust holiday sales from last year (Atlanta and Kansas City) and some reporting sluggishness in holiday sales (New York) but still up from last year. Auto sales are decreasing. The Beige Book, the Fed s Empire State Manufacturing Survey, and the Philadelphia Fed Business Outlook Survey confirmed that manufacturing was slowing in the New York district but growing robustly in the Philadelphia district. The Empire State Manufacturing Index fell from 11.9 to 3.9 (consensus was 10.0) and Philadelphia s rose from 9.4 to 17.0 (consensus was 9.0) Fed regional surveys show economy moving in two different directions (SA, diffusion index) -30 Philadelphia -40 Empire State Source: Federal Reserve Board of Philadelphia, Federal Reerve Board of New York, National Bureau of Economic Research The Atlanta Fed s Q4 GDPNow forecast remains at 2.8% from last week, as scheduling updates are being postponed due to the Commerce Department s shutdown. (The Atlanta Fed relies primarily on hard data.) The NY Fed revised its Nowcast up from 2.48% to 2.57% led by positive surprises in industrial production and capacity utilization. The World Economic Forum meets next Tuesday in Davos. This year s theme is Shaping a Global Architecture in the Age of the Fourth Industrial Revolution, with key issues centered on geopolitics, the global economy, institutional reform, human capital and society, industry systems and technology, and risk resilience. More interesting than who is attending, is who is not attending. The list includes President Trump and the entire US delegation, President Macron, and PM Theresa May. PM Theresa May will be in the UK to present an alternative Brexit deal to Parliament. In addition to Davos, the BOJ and ECB monetary policy meetings are next Wednesday and Thursday, respectively. Traders are expecting no changes in key interest rates from either central bank, but tweaks in forward guidance parlance, inflation targets, economic growth outlooks, as well as reinvestment of principal securities could cause some market volatility, especially with Davos in the backdrop. Page 7 of 10

8 THE WEEK AHEAD JANUARY 18, 2019 Preview Note: «= High Impact Event All times Eastern Standard Due to the government shutdown, both data collection and reporting will be delayed at the Department of Agriculture and the Commerce Department. (The latter funds the Census Bureau and the Bureau of Economic Analysis.) Some data already reported by these two departments are likely to be revised when subsequent reports are released. Congress fully funded the Bureau of Labor Statistics until September 2019, so monthly employment reports, CPI, PPI, and other BLS reports will continue without disruption. The Fed is self-funding and will continue to release data. The following statistics could be released at some point during the week. Delays are likely for a period after the government reopens. Advance Goods Trade Balance Wholesale Inventories Retail Inventories New Home Sales Construction Spending Factory Orders Durable Goods Orders & Shipments Trade Balance Wholesale Trade Monthly Budget Statement Retail Sales TIC Flows Sunday, January 20 9:00pm China: Q4 GDP Retail Sales Industrial Production Fixed Assets Ex Rural 13.0% 12.0% China GDP expected to continue falling (Real GDP, NSA, Y/Y %) 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% Source: National Bureau of Statistics of China Page 8 of 10

9 THE WEEK AHEAD JANUARY 18, 2019 Monday, January 21 US: Public Holiday «UK: PM Theresa May presents Parliament with an alternative Brexit proposal. «8:00am Davos: The IMF releases its World Economic Outlook Update. (Press conference and report are here.) 2:00am Germany: PPI Tuesday, January 22 Annual World Economic Forum begins in Davos (through Friday). 4:30am UK: ILO Employment Report Public Sector Finances 5:00am EU: ZEW Survey Expectations 8:30am Canada: Manufacturing Sales 10:00am US: Existing Home Sales 11:30am US: $42bn 3M and $39bn 6M Treasury Bill Auctions 6:50pm Japan: Trade Balance Wednesday, January 23 «Japan: BOJ monetary policy decision 2:45am France: Business Climate Index 8:30am Canada: Retail Sales 9:00am US: FHFA House Price Index 10:00am US: Richmond Fed Manufacturing Index 10:00am EU: Consumer Confidence 7:30pm Japan: Nikkei Manufacturing PMI Thursday, January 24 3:15am France: Markit Composite PMI 3:30am Germany: Markit/BMI Composite PMI 4:00am EU: Markit Composite PMI «7:45am EU: ECB monetary policy decision 9:45am US: Bloomberg Consumer Comfort Markit Composite PMI 10:00am US: Leading Index 11:00am US: Kansas City Fed Manufacturing Index 11:30am US: 4W and 8W Treasury Bill Auctions Page 9 of 10

10 THE WEEK AHEAD JANUARY 18, 2019 Friday, January 25 4:00am Germany: IFO Survey 8:30am US: Durable Goods Orders and Shipments (Census Bureau may be delayed) New Home Sales (Census Bureau may be delayed) Rebecca Kooshak, Economic Analyst Although this information has been obtained from sources which we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. This is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results, while changes in any assumptions may have a material effect on projected results. Ratings on all securities are subject to change. The views expressed herein accurately reflect the author s personal views about the subject securities or issuers. No part of their compensation was, is or will be directly or indirectly related to the specific recommendations or views contained in the Notes. FTN Financial Group, FTN Financial Capital Markets, FTN Financial Portfolio Advisors and FTN Financial Municipal Advisors are divisions of First Tennessee Bank National Association (FTB). FTN Financial Securities Corp (FTSC), FTN Financial Main Street Advisors, LLC, and FTN Financial Capital Assets Corporation are wholly owned subsidiaries of FTB. FTSC is a member of FINRA and SIPC FTN Financial Municipal Advisors is a registered municipal advisor. FTN Financial Portfolio Advisors is a portfolio manager operating under the trust powers of FTB. FTN Financial Main Street Advisors, LLC is a registered investment advisor. None of the other FTN entities including, FTN Financial Group, FTN Financial Capital Markets, FTN Financial Securities Corp or FTN Financial Capital Assets Corporation are acting as your advisor and none owe a fiduciary duty under the securities laws to you, any municipal entity, or any obligated person with respect to, among other things, the information and material contained in this communication. Instead, these FTN entities are acting for their own interests. You should discuss any information or material contained in this communication with any and all internal or external advisors and experts that you deem appropriate before acting on this information or material. FTN Financial Group, through FTB or its affiliates, offers investment products and services. Investment Products are not FDIC insured, have no bank guarantee and may lose value First Tennessee Bank. All rights reserved. Page 10 of 10