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Wednesday's report on June sales of existing homes reminds us that real estate is still in a slump. The National Association of Realtors reported that sales of single-family homes tumbled 3.8% last month to an annualized rate of 5.75 million units - the lowest in almost five years.

More weakness may be coming, predicted Thomas Higgins, chief economist at money manager Payden & Rygel, in a research note sent to clients on Wednesday. He reasoned that the recent jump in mortgage rates will keep the pressure on sales in the coming months. He explained that a high correlation (77%) between mortgage rates and a two-month lag on existing home sales suggest as much, as per his chart below.

click to enlarge
Home Sales Chart
Source: Payden & Rygel

"Between May 11 and July 13, the rate on a 30-year fixed-rate mortgage surged from 6.15% to 6.75%," Higgins wrote. "As the chart above shows, a rise in mortgage rates tends to impact existing home sales with a two month lag." As a result, he warned that existing home sales "could see another down leg in July and August."

This line of thinking throws a potential wrench into the machine of optimism, which of late has espoused the idea that the worst of real estate's ills had passed. The sector isn't necessarily poised for boom or even modest rebound. But if the market would simply stop bleeding, the flat-lining would go a long way toward boosting the economy in the second half of 2007 into 2008.

The reasoning runs like this: housing-related trouble has been a key reason for the downturn in gross private domestic investment, which is a leading factor for calculating GDP. The other big variable - consumer spending - has continued bubbling, but not enough to totally offset the weakness in private investment. As a result, the real estate pain helped trim GDP growth in the first quarter to an annualized rate of just 0.7% - the slowest in recent years. But if the housing slump would simply level off, and consumer spending more or less continued at the recent trend, the GDP would then rebound handsomely.

Housing, of course, is a huge industry and encompasses more than just sales. As such, getting a handle on a broader measure of real estate requires looking at several statistics beyond sales, including housing starts, and housing permits. On those fronts there's mixed news in the June data (pdf), which was released last week.

Housing starts posted their first monthly rise since February, advancing 2% in June. But new housing permits (a signal of future activity in the sector), continued falling and dropped 7.5% in June from the previous month. (Both series are calculated at seasonally adjusted annualized rates.)

Still, expectations for the broader economy remain modestly encouraging, in part because the growth around the world is still bubbling. "The global economy continued to expand at a brisk pace in the first half of 2007," the IMF reported on Wednesday in its updated World Economic Outlook.

The survey also offered reasons to stay upbeat on the United States. Charles Collyns, deputy director of the IMF's research department, told reporters at a press briefing on Wednesday that, "Although growth in the United States slowed in the first quarter, recent indicators suggest that the U.S. economy gained strength in the second quarter."

World GDP is expected to rise 5.2% for all of 2007, slightly lower than last year's pace, according to the latest IMF prediction, and U.S. GDP is forecast to expand by 2.0% for this year, down from 3.1% in 2006.

The future, of course, arrives one quarter at a time for GDP, with the next installment coming on Friday, when the Commerce Department releases its advance estimate for economic growth. The consensus prediction calls for a rise of 3.2% in 2Q GDP, according to TheStreet.com. If so, that would be a sharp rebound from Q1's meager 0.7%.

In the meantime, the struggle between the forces of growth and contraction continue. Growth still has the upper hand, but the forces of darkness aren't banished yet.

Source: Optimism Takes a Hit as Real Estate Continues to Slump