Even as Economy Remains Stronger Than Projected, Fannie Mae Forecast Still Sees ‘Eventual Downturn’

WASHINGTON—Recent economic data points to a stronger economy than previously expected, but the current business cycle “contours” still point to an eventual downturn, according to the August 2023 commentary from the Fannie Mae Economic and Strategic Research Group.

Given the “recent flurry of strong consumption data combined with two consecutive months of annualized Consumer Price Index (CPI) measures coming in close to the Fed’s 2% inflation target,” the ESR Group noted that the odds of a “soft landing” have increased, Fannie Mae said.

However, the ESR Group added, the full lagged effects of monetary policy tightening are still working their way through the economy.

The ESR Group analysis, for example, said wage growth also likely remains too high to be consistent with 2% inflation over the long run, which it believes will keep monetary policy tight. Additionally, the ESR Group posited that the recent rise in medium- and longer-term Treasury yields will likely weigh on interest-rate-sensitive sectors in coming quarters.

The ’If’ and the ‘When’

While the ESR Group noted that both the “if” and “when” of a recession are uncertain given the strength of recent economic data and decelerating inflation, their baseline forecast is for one to occur, now expected to begin in the first half of 2024, Fannie Mae said.

Regardless of whether the economy enters a recession, the ESR Group is forecasting home sales will remain subdued within a tight range.

If the economy avoids a recession, the ESR Group said it expects home sales activity would continue to be suppressed by a lack of existing home inventory for sale combined with continued affordability constraints and homeowners remaining “locked in” to their low mortgage rate.

The Alternative

Alternatively, if the economy enters a recession, improvements in affordability and inventory stemming from likely lower interest rates is expected to be offset at least in part by a weaker labor market, tighter credit, and worsened consumer confidence, Fannie Mae said.

“Regarding new homes, both sales and construction have performed comparatively well despite higher mortgage rates to date; however, the ESR Group notes some downside risk given mortgage rates are again near 7% and homebuilder confidence pulled back in August,” Fannie Mae said.

Easy to Run ‘Aground’

“It is easy to run your forecast ship aground by underestimating the American consumer,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “Despite reduced saving, increased rollover credit card balances, and rising credit costs, consumers are sustaining consumption, supported by a decline in inflation.

“Nonetheless, tightening monetary policy takes a toll,” continued Duncan. “Will it result in a recession? Our base case forecast is a mild recession, and it looks as though the alternative is a soft landing, which is slow growth with only a small increase in unemployment. The difference between those two alternative outcomes is not expected to make much difference to home sales. The risk to housing activity is that inflation has bottomed out and begins to reaccelerate, requiring additional tightening from the Fed.”