After a rocky start to the year, construction activity in the US has increased sharply over the past four months and poses some upside risk for the economic outlook. With the household sector weighed down by debt and soft wage growth, the Federal Reserve would be relieved to see the construction sector bounce back -- even if progress has been slow.
In the US construction activity rose by 1.8 per cent in July, beating market expectations, to be 8.2 per cent higher over the year. Activity has picked up over recent months -- albeit not in all categories -- after a fairly soft start to the year.
Growth was driven by non-residential and public construction. Non-residential construction increased by 2.1 per cent in July but remains 17 per cent below its peak. Public construction rose by 3.0 per cent but activity has been fairly subdued, highlighting the austerity measures implemented across every level of government.
Residential construction rose by 0.7 per cent in July but has eased in recent months and is still 47 per cent below its 2006 peak. But clearly there is some upside risk for residential construction; while there was an oversupply of property in the lead-up to the global financial crisis, the overhang certainly wasn’t as large as the construction response in the graph above indicates.
Consistent with this, housing starts continue to surge, rising by almost 22 per cent over the year to July and clearly there is a fair bit of construction left in the pipeline. However, one of the risks for the construction outlook is house prices, which have declined modestly in the past couple of months.
Residential and non-residential investment currently account for 5.9 per cent of real GDP -- obviously not a high share -- but there is scope for it to rise to say 7 to 7.5 per cent without triggering a collapse in prices. With many businesses flushed with cash -- but more than happy to park it in equities and bonds while rates are low -- I expect investment to pick-up once the Fed begins to move on their cash rate next year.
That would be a welcome turn of events for an economy that continues to rely disproportionately on the consumer. As I explained on Monday, there is a very good reason to believe that consumer spending growth may not return to its pre-crisis heights and the US economy will need to transition towards other sources of growth (Cautious consumers are not helping the US recovery; September 1).
But while there is scope for greater activity there remains no shortage of risks. Bank lending remains subdued -- particularly given current lending rates -- while households continue to deleverage. Supply constraints threaten to slow the recovery in construction over the next couple of years.
Income growth and high levels of student debt continue to weigh on activity and prices. Hopefully the former will ease somewhat as conditions in the labour market continue to improve and businesses begin to compete for the best candidates. The latter will be a more persistent problem.
Overall this was a very strong construction report and while residential construction has eased somewhat recently there should be plenty of construction left in the pipeline. Other data out overnight was also strong -- including the ISM manufacturing survey -- which paints a pretty solid picture for activity in the September quarter.
Obviously none of this will genuinely affect the Fed’s near-term outlook. Nothing short of a disaster will shift it from cutting its asset purchasing program at its September and October meetings but a stronger outlook for construction, if realised, will go some way to encouraging rates to rise next year.
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