In May, we’ll go deep on money and finance for a special theme month, by talking to leaders about where the mortgage market is heading and how technology and business strategies are evolving to suit the needs of buyers now. A prestigious new set of awards, called Best of Finance, debuts this month too, celebrating the leaders in this space. And sign up to Mortgage Brief for weekly updates all year long.

Inflation remains stubborn, but Federal Reserve rate hikes and tightening bank lending standards are still likely to lead to a “modest recession” later this year Fannie Mae economists said Friday in their latest forecast.

In the meantime, housing continues to outperform expectations this year, even if “extraordinarily tight” inventories of existing homes has shifted demand toward the new home market.

Strength in new home construction, auto sales and labor markets means there’s even a risk that the Fed will continue raising rates if inflation doesn’t cool, and Fannie Mae economists no longer expect mortgage rates to fall below 6 percent this year, as forecast in April.

“There are select data available to support several alternative views of the path of the economy, though we maintain our view that a modest recession will begin in the second half of 2023,” Fannie Mae Chief Economist Doug Duncan said in a statement. “Housing remains exhibit No. 1 for why we expect the recession to be modest. It continues to outperform our expectations, and we expect that its relative strength will help kickstart the economy into expanding again in 2024.”

While Fannie Mae economists think strength in new home construction and auto sales could yet help the economy manage a “soft landing” without a recession, April’s strong job numbers and continued pressure on wages remain inconsistent with the Fed’s long-term goal of bringing inflation back down to 2 percent.

That raises the possibility that instead of pausing interest rate hikes or even bringing rates back down to head off a recession, as many bond market investors expect, the Fed will be forced to raise rates again.

“Inflation has been resistant to Fed efforts to drive it down, and we view the risks to our baseline forecast as tilted toward more tightening rather than easing – although, for the moment, the Fed has adopted a wait-and-see approach,” Duncan said.

Speaking at an economic conference Friday, Federal Reserve Chair Jerome Powell repeated past assurances that future rate decisions will be based on the latest inflation data. Tightened bank lending standards driven by the recent failures of Silicon Valley Bank, Signature Bank and First Republic Bank could help the Fed achieve its inflation-fighting goals, but it will take time to understand the impacts.

Turmoil in the banking sector is “contributing to tighter credit conditions and are likely to weigh on economic growth, hiring and inflation,” Powell said, meaning the federal funds rate “may not need to rise as much as it would have otherwise to achieve our goals.”

But historically, monetary tightening cycles typically end in a recession, Fannie Mae economists warned — particularly when the Fed is reacting to inflation, as it is now, rather than moving proactively to preempt it.

“Historically, a meaningful rise in the unemployment rate, often coinciding with something ‘breaking’ in the financial system, has been the way inflation is contained once it is well above target,” Fannie Mae economists said in commentary accompanying their May forecast. “We believe this to be currently playing out now, with the Fed continuing to cite a desire to loosen the labor market along with recent bank failures and growing weakness in commercial real estate.”

Fannie Mae forecasts gentler descent in mortgage rates

Many bond market investors expect the Fed to reverse course and begin lowering rates this year as the economy cools. But Fannie Mae economists say the Fed is likely to keep interest rates elevated until it sees evidence that the tightening it’s already implemented is moving the numbers in the right direction.

“We believe the Fed is unlikely to be convinced that inflation is under control until the labor market softens sufficiently, so we think it probable that policy will remain tight until a contraction is under way,” Fannie Mae economists said.

While Fannie Mae forecasters still expect mortgage rates to trend down this year and next, they’re projecting a gentler downward glidepath than they did in April.

In April, Fannie Mae economists were envisioning that rates on 30-year fixed-rate mortgages would dip below 6 percent in the third quarter of this year and fall to an average of 5.7 percent during the fourth quarter of 2023.

Now, with inflation still looking problematic, Fannie Mae economists don’t see mortgage rates dipping below 6 percent until the first quarter of 2024. The latest forecast is for rates to dip to an average of 5.4 percent during the fourth quarter of 2024, instead of 5.2 percent in April’s forecast.

Economists at the Mortgage Bankers Association, who forecast in April that mortgage rates would dip below 5 percent next year, hadn’t yet issued their May forecast as of Friday.

Outlook for 2023 new home sales upgraded

Strength in new home sales, which have been trending upward since last fall and jumped 9.6 percent in March, prompted Fannie Mae forecasters to raise their projection for 2023 new home sales to 640,000, up 2 percent from April’s forecast of 629,000.

“While we expect sales to soften somewhat later in the year, consistent with our recession forecast, the new housing market appears to be more upbeat than it was to start the year,” Fannie Mae economists said, citing the fifth consecutive increase in the National Association of Home Builders’ sentiment survey in May.

“Additionally, many of the large publicly traded homebuilders discussed in their first-quarter earnings calls a more upbeat outlook for the remainder of the year,” Fannie Mae forecasters noted. “A common theme was stabilization in prospective foot buyer traffic and the needed level of concessions and rate buydowns to drive sales.”

New home sales are expected to soften next year, however, as tightening credit for construction lending is expected to slow housing starts later this year and a record number of multifamily units now under construction come onto the market.

Fannie Mae economists expect sales of existing homes will likely remain subdued for the rest of the year, thanks to a lack of inventory and the ongoing persistence of the “lock-in effect,” which discourages existing homeowners with low mortgage rates from putting their homes on the market.

Fannie Mae economists made only minor adjustments to their forecast for existing home sales from April to May, saying they expect 2023 sales to decline by 16 percent from last year to 4.217 million, before rebounding 4 percent next year to 4.381 million.

Mortgage refis expected to nearly double next year

With mortgage rates falling more gradually than expected, Fannie Mae economists downgraded their forecast for 2023 refinancings by $21 billion from April to $291 billion. While refis are expected to rebound by 92 percent next year to $558 billion, that’s $26 billion less than forecast in April — and a drop in the bucket when compared to the $2.67 trillion in mortgages refinanced when rates hit record lows in 2021.

Purchase mortgage originations are expected to track down with home sales and cooling home price appreciation, falling 18 percent this year to $1.359 trillion. But if home sales rebound next year as forecast, purchase mortgage originations are expected to rebound by 8 percent next year to $1.468 trillion.

Get Inman’s Mortgage Brief Newsletter delivered right to your inbox. A weekly roundup of all the biggest news in the world of mortgages and closings delivered every Wednesday. Click here to subscribe.

Email Matt Carter

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