Despite ending the year on a stronger-than-anticipated footing, the economy is still expected to slip into a modest recession beginning in the first half of 2023, according to the January 2023 commentary from the Fannie Mae Economic and Strategic Research (ESR) Group. The ESR Group views the current rate of consumption as unsustainable relative to disposable income and forecasts that an eventual retrenchment of the consumer will be a major factor in the upcoming economic contraction.
The ESR Group predicts Q4/Q4 GDP growth for 2023 to be negative 0.6%, one-tenth lower than its previous forecast. Noting cooling inflationary pressure in the past three Consumer Price Index (CPI) reports, the ESR Group believes the Federal Reserve is likely nearing its eventual terminal rate but notes that upside risk remains for tighter-for-longer monetary policy should a recession be delayed or avoided altogether, or, alternatively, if inflation measures fail to further cool.
Further, the ESR Group expects a cumulative 6.7% home price decline over the next two years as housing affordability remains unsustainably stretched. A repeat of the Great Financial Crisis is not expected, however, as far fewer borrowers are facing interest rate shocks, loan workout and modification programs are more robust, and aggregate residential real estate and the broader financial system are substantially less leveraged compared to the 2006-2008 period. Instead, housing affordability is forecast to gradually improve over the longer term due to a combination of home price declines, modestly lower mortgage rates, and stronger-than-usual nominal income growth.
Ongoing affordability challenges and the “lock-in effect” – in which many current homeowners have a financial disincentive to list their homes due to the higher mortgage rate environment – have the ESR Group expecting existing home sales activity to remain constrained, creating an avenue for the new home sales trend to comparatively outperform existing home sales in coming years.
“There are economic signals pointing to recession but also signs that a ‘soft landing’ may be in the offing,” says Doug Duncan, senior vice president and chief economist at Fannie Mae. “In our view, the balance still suggests a modest recession, particularly if the Federal Reserve maintains its focus on labor market tightness. While limited and tentative signs of a slowing labor market are appearing, overall, labor remains robust. The market sees the Federal Reserve easing in the second half of the year, which can be interpreted either as a view that the recession is forthcoming or that the slowdown in inflation will lead to a less restrictive monetary posture.”
“If the latter occurs, the lower accompanying rates will likely set the stage for a pickup in housing activity going into 2024, as can be seen in our latest forecast,” Duncan adds. “However, if the market is wrong – and the Federal Reserve does as it has stated it will do and holds the federal funds target at the terminal rate longer to ensure no inflation resurgence – then the accompanying rate decline and associated revival in housing activity will likely be delayed. In either case, we expect 2023 to be a slow year for the housing market.”