If builders cut back, are they doing so because demand has slowed, or because they are concerned demand will slow in the future? Both, I suspect. They're seeing some signs of softening and they're getting concerned about holding too much inventory.
Unlike most other products, homebuilders need to move inventory as quickly as possible because inventory costs are very high. Only the large homebuilders like Pulte Homes, Inc. (PHM) and Centex Corporation (CTX) can afford to sit on inventory for any significant length of time. Small builders count on the proceeds from finished projects to fund future starts. So builders only want to build what they know they can move quickly. If homebuilders are holding inventory longer, they are going to be slower to start new projects.
But also, they will tend to be more conservative on the future. If builders cut back too much, there won't be enough new homes to meet demand six months from now and prices will rise. This is a real possibility given the strength of the economy and the fact that the slowing housing market is mostly the product of a media-induced scare.
Last fall, the media and analysts began predicting a slowdown before there were any economic indications to suggest it. So it's a reflexive slowdown. That is, the slowdown is entirely the result of peoples' actions anticipating a slowdown, and has little to do with fundamental supply, demand, or interest rates.