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After nearly 18 months of effort to tame inflation and cool the economy, including 11 short-term rate hikes by the Federal Reserve, economic indicators are beginning to show signs of slowing. The August jobs report from the Bureau of Labor Statistics represented the second consecutive month of job growth below 200,000, while inflation is averaging year-over-year growth just above 3%, a marked improvement from nearly 9% in July 2022.

Ali Wolf, chief economist for Zonda, says the cooling in the past couple jobs and inflation readings are “important step[s]” to allow the Fed to consider when they might be done raising rates. Mike Fratantoni, senior vice president and chief economist of the Mortgage Bankers Association (MBA), adds the August jobs report “should be enough” for the Fed to keep the Federal Funds target rate on hold.

“The most recent jobs report shows that the economy is still adding jobs, but at a slower pace than seen over the past few years,” Wolf says. “In addition, inflation is trending back toward the Fed’s 2% target. The tricky part now is what can be referred to as the last mile: getting inflation back to a healthy level and holding it there.”

The next actions of the Federal Reserve will be important as it attempts to achieve a soft landing, defined as a cyclical slowdown in economic growth that avoids a recession. NAHB chief economist Robert Dietz says it would be “unusual” given the degree of tightening from the Federal Reserve and quantitative tightening if there was not “some kind of macroeconomic downturn.”

“We had a decline in the annualized rate of GDP in the first quarter and the second quarter of 2022, but the academics [at the National Bureau of Economic Research] did not declare the beginning of a recession in 2022 because the unemployment rate was low,” says Dietz.

The Fannie Mae Economic and Strategic Research Group says recent data reports have increased the odds of a soft landing. For the NAHB and Dietz, the classification of whether a soft landing has been achieved or a recession is occurring is difficult given the nature of how individual sectors have slowed at different times over the past 18 months.

“The start of 2022 coincided with a downturn in the home building sector, manufacturing also experienced some weakness in 2022 spilling into 2023. Other sectors of the economy are weakening,” Dietz says. “I think this is best characterized not with the soft landing versus hard landing nomenclature, but rather a rolling recession. What we’ve got are individual sectors of the economy reacting at different times to the tightening of monetary policy and thereby showing weakness at different times. Not all the traditional signposts that would occur during a recession [are] occurring at the same time period, thus making the classification of it a little difficult.”

Fannie Mae’s ESR Group shares a similar sentiment, noting that both the “if” and “when” of a recession are uncertain in classification terms. The group projects a recession to occur beginning in the first half of 2024.

Wolf agrees that the odds of a recession next year are “more likely than not given the risks related to commercial real estate, the Fed, and anticipated changes in consumer behavior.”

“Despite reduced savings, 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,” says Doug Duncan, senior vice president and chief economist of Fannie Mae. “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.”

Wolf says a “systematic collapse” of the commercial real estate sector or more widespread bank failures are the biggest factors that could contribute to a recession being “significant and prolonged” rather than mild.

“If we simply see select parts of the economy slow, but not crash, a mild and not particularly painful recession could ensue,” says Wolf.

The Federal Reserve, the Federal Funds Rate, and the Housing Market

With the labor market and inflation beginning to cool, Dietz says the cadence, magnitude, and structure of rate pauses and cuts are “among the most important variables for the U.S. economy right now.”

“[The Federal Reserve] has been communicating for more than a year that their strategy is going to be higher [rates] for longer,” Dietz says. “From a builder and housing perspective, there are some analysts who have made the call that the Fed is going to begin easing right away. I think [they’ll] probably end up waiting until the second half of 2024.”

Dietz and Wolf both say they believe the Fed will raise rates again, which could add some short-term strain on the market as it tries to figure out the right amount of monetary policy necessary to slow growth without causing a contraction. The outlook for the Federal Funds Rate likely means that mortgage rates are “close to the peak,” if not currently there, according to Dietz. The NAHB projects the 30-year fixed-rate mortgage will decrease to an average at or below 6% over the course of 2024.

Duncan says whether the economy is pulled into a mild recession or a soft landing, the outlook for the housing sector will remain relatively consistent. If the economy avoids a recession, Fannie Mae projects home sales activity would continue to be suppressed by a lack of existing-home inventory and affordability constraints as mortgage rates would remain elevated. If the economy enters a recession, Fannie Mae’s ESR Group forecasts improvements in affordability and inventory stemming from lower interest rates would likely be offset in part by a weaker labor market, tighter credit, and worsened consumer confidence.

“The difference between those two alternative outcomes [recession or soft landing] is not expected to make much difference to home sales,” Duncan says. “The risk to housing activity is that inflation has bottomed out and begins to reaccelerate, requiring additional tightening from the Fed.”

Wolf says the market share improvement home builders have experienced as existing homeowners have been reluctant to sell may continue moving forward, but at a reduced magnitude. Consumers that are locked in at rates in the 2% to low 3% range will likely remain reluctant to sell even in a market where interest rates return to the 5% range.

“That [element of the lock-in effect] feels like a longstanding issue in the resale market,” Wolf says. “For people that have locked in a high 3% or 4% interest rate, market rates getting back to the 5% [range] may be enough for them to sell and move.”