As the housing market completed its 11th consecutive quarterly decline and the residential slump extended into its 4th calendar year, the pace of the slide accelerated at the end of 2008. New housing starts fell 15.5% in December to 550,000 units. Single-family starts, off 14.2% in November, fell another 13.5% to 398,000 units in December. In the 50 years that these data have been compiled, December marked the lowest level of activity recorded. Additionally, the 64.8% annualized pace of decline in Q4 was the most rapid quarterly decline ever. The momentum of recent housing declines has increased in response to the overall economic weakness inherent in the steep recession. Finally, single-family starts in December were off 48.9% from a year earlier, the largest year-over-year decline of the current collapse.

Building permits, a leading indicator for future residential construction activity, also continued to weaken last month. Overall building permits were off 10.7% in December to 549,000 units, while single-family permits dropped 12.3% to a record low 363,000 units. With a variety of headwinds facing the housing industry, including rising unemployment and tight credit conditions, the construction activity is expected to decline until at least mid-2009.

The number of homes completed fell 5.2% in December, while the number under construction fell 3.3%, the 31st consecutive month of decline. For the past 4 months, the number of homes under construction has fallen by at least 3.0% each month, indicating that residential investment was a sizable drag on real GDP growth in 4Q 2008, a trend that will continue in early-2009.

With the FOMC maintaining its target funds rate in a range of 0 to ¼ percent, while retaining its focus on sustaining the size of the Fed’s balance sheet at a high level, the element of surprise at this week’s meeting is limited. The FOMC will note that labor market conditions and economic activity have continued to deteriorate and inflation pressures have diminished. It will also maintain its intention to keep the fed funds rate exceptionally low for some time. The Committee will again indicate its plans to support particular financial markets, and may provide further specificity concerning security purchases and the implementation of the Term Asset-Backed Securities Loan Facility (TALF).

The behavior of inflation and inflation expectations is receiving heightened scrutiny amid the current economic and financial crisis. The worldwide slowdown and large declines in energy and other commodity costs sharply reduced headline inflation rates, shifting concerns late last year from rising inflation to the dangers of deflation. Moreover, declining U.S aggregate demand has further reduced price pressures, while pervasive job losses increase labor market slack, restraining compensation. Breakeven inflation rates from TIPS and cash Treasury markets plummeted in late-2008 and remain subdued. In the December Fed minutes, some members mentioned greater specificity on a long-run desired inflation rate, presumably as a means to anchor inflationary expectations. Since the meeting, the Fed’s credit easing through the explicit use of its balance sheet and the growing likelihood of a huge fiscal stimulus package from the new Administration have stabilized and even helped reverse measures of inflation expectations. Last week’s jump in coupon yields on cash Treasuries should be viewed in this context.