by Calculated Risk on 11/13/2009 12:54:00 PM

This is an update to an earlier post. As I've noted for some time, housing leads the economy and is the best leading indicator for the economy - both into and out of recessions.

Update: Employment tends to be a coincident indicator into recessions, and used to be coincident coming out of recessions. Employment has lagged the economy after the previous two recessions (and appears to be lagging again).

Employment lags housing, and the following graph shows the relationship between starts and unemployment.

The graph is based on a talk by Jon Fisher, a professor at the University of San Francisco School of Business.

Click on graph for larger image in new window.

This graph shows housing starts (both total and single unit) and unemployment (inverted).

You can see both the correlation and the lag. The lag is usually about 12 to 18 months, with peak correlation at a lag of 16 months for single unit starts. The 2001 recession was a business investment led recession, and the pattern didn't hold.

This suggests unemployment might peak in Spring 2010.

Professor Fisher argued that unemployment will rise to about 10.4% and then fall rapidly. He is now projecting unemployment will decline to 8% by the end of 2010.

He is basing the rapid decline in unemployment on a "V shaped" housing recovery similar to previous recessions. I disagree with that point.

In most earlier recessions, the slumps were caused by the Fed raising interest rates to fight inflation. When the Fed cut rates, housing bounced back sharply (V shaped).

Although this recession was led by a housing bust - and that makes it look similar to some previous periods - this recession was not engineered by the Fed raising rates, rather it was the busting of the credit and housing bubbles, and all the related problems that led the economy into recession. Since there is still far too much existing home inventory, a sharp bounce back in housing starts is unlikely, so I think Fisher's forecast for a rapid decline in unemployment is also unlikely.