Higher mortgage rates are now “housing market’s primary constraint,” economists at Fannie Mae said in a new forecast predicting home sales will fall 13.5 percent this year.

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Higher mortgage rates “are now the housing market’s primary constraint,” economists at Fannie Mae said in a new forecast predicting home sales will fall 13.5 percent this year, and that the Federal Reserve’s increasingly aggressive efforts to combat inflation “will likely result in a recession” next year.

The latest forecast from Fannie Mae’s Economic and Strategic Research Group, released Thursday, paints a more dire picture than May’s forecast, which envisioned an 11.1 percent drop in 2022 home sales. In January, Fannie Mae forecasters predicted that although rising mortgage rates and home prices would price many homebuyers out of the market, 2022 home sales would decline by just 1.2 percent.

What’s changed are expectations about how far, and how fast, the Fed will have to raise short-term interest rates to combat inflation. On Wednesday, Fed policymakers approved the biggest interest rate hike in 28 years, following Friday’s release of a Labor Department report that showed inflation hitting 8.6 percent in May — the highest reading in more than 40 years.

Doug Duncan | Photo credit: Fannie Mae

“Our view continues to be that the magnitude of response required of monetary and fiscal tightening to return inflation to the Federal Reserve’s target will likely result in a recession, which we currently expect will be modest and occur next year,” Fannie Mae Chief Economist Doug Duncan said in a statement. “Notably, the recent market response to continued heightened inflation suggests that the predicted recession could occur sooner and be deeper than our current baseline forecast.”

Home sales projected to fall by 13.5% this year, and another 11.2% in 2023

Source: Fannie Mae June 2022 Housing Forecast.

Recent, weaker-than-expected data on new home sales and mortgage applications prompted Fannie Mae economists to revise downward their forecast for 2022 home sales to 5.96 million units, which would represent a 13.5 percent decline from 2021. The latest forecast envisions home sales dropping by another 11.2 percent in 2023, to 5.29 million units, down from May’s forecast of 5.42 million sales.

Based on recent data on home sales and mortgage applications Fannie Mae economists downwardly revised their forecasts for sales of both new and existing homes.

Although the 2.4 percent decline in existing home sales seen in April was in line with expectations, “recent incoming mortgage application data points to a faster-than-anticipated further decline” entering the third quarter, Fannie Mae economists said in commentary accompanying their latest forecast.

New home sales came in “well below expectations,” falling 16.6 percent in April to the slowest pace since 2020 COVID-19 shutdowns. But Fannie Mae economists said they’re “partially discounting the magnitude of the drop-off,” in new home sales, suspecting that many homebuilders were “caught off guard by the degree of mortgage rate increases this spring and the resulting shrinkage of homebuyer waiting lists. The number of new homes available for sale continues to grow, while a record number of homes are currently under construction.”

The forecast was completed on June 10 — before the Fed’s latest interest rate hike, meaning next month’s forecast could include more downward revisions.

“The recent upward movement in interest rates since the completion of our rate forecast points to further downside risk to our already downwardly revised sales outlook,” Fannie Mae economists said.

Mortgage refinancings expected to drop by 69% this year

Source: Fannie Mae June 2022 Housing Forecast.

With fewer home sales expected, Fannie Mae economist revised lower their forecast for 2022 mortgage originations to total $2.61 trillion (previously $2.70 trillion), and for 2023 originations to total $2.20 trillion (previously $2.25 trillion).

Most of that drop is due to the fact that higher mortgage rates mean fewer homeowners have an incentive to refinance. With only 2 percent of outstanding mortgages having at least a 50-basis-point incentive to refinance, Fannie Mae projects refinancing volume to drop 69 percent this year, to $797 billion, and by another 35 percent in 2023, to $518 billion.

Thanks in part to rising home prices, purchase loan volume is projected to decline by a more modest 3 percent this year, to $1.808 trillion, and by another 6.7 percent in 2023, to $1.686 trillion. But rising home prices and mortgage rates are expected to constrain homebuyer demand.

“The significant, sudden rise in interest rates is beginning to be felt widely as employment growth slows and stock market valuations fall,” Duncan said. “Nowhere is this more evident than in housing affordability measures, with the prospective monthly payment on a typical new mortgage climbing dramatically. As a result, both new and existing home sales continue to slow, while refinance activity has fallen substantially, with what’s left largely consisting of equity extraction.”

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Email Matt Carter

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