The big drop in new home sales in May was most likely "payback" for strong sales in April, which in turn were fueled by people rushing to take advantage of the soon-to-expire homebuyers tax credit of $8,000. As Brian Wesbury notes, the underlying level of sales is consistent with the very low level of new construction we have seen for the past year, and does not therefore represent any new deterioration in the economy. Bear in mind as well that residential construction has fallen to its lowest level relative to the economy (just over 2% of GDP), so even if new home construction were to weaken substantially from here it would have a minimal impact on the overall economy.
... new homes were sold at a 446,000 pace in April, but fell to a 300,000 rate in May. The underlying trend is probably in between, or 373,000 per year. For comparison, in the past two months, single-family homes were started at a 517,000 annual rate. Of the 517,000, we estimate that roughly 150,000 do not need to be sold because the plot has already been sold. That leaves 367,000 per year that need to be sold (517,000 minus 150,000), which is right in-line with the pace of sales. In other words, as bad as today’s report was, it does not signal a need for home builders to slow down the pace of construction. Confirming this, today’s report showed that the inventory of new homes declined 1,000 to 213,000, the lowest level since 1970.