A combination of economic factors, including inflation and monetary policy tightening, led many economists to forecast the economy would enter a recession in 2023. As early as April 2022, Fannie Mae’s Economic and Strategic Research (ESR) Group projected a “mild recession” for 2023. However, the group expects housing will both contribute to the mild nature of the recession and help lead the economy into recovery.
Doug Duncan, senior vice president and chief economist for Fannie Mae, and Mark Palim, vice president and deputy chief economist for Fannie Mae, spoke with BUILDER to share the economic and housing forecasts of the government-sponsored enterprise's ESR Group for this year.
BUILDER: Despite ending 2022 on “stronger-than-anticipated” footing, Fannie Mae is still forecasting the economy will fall into a recession in 2023. How has the end of year shifted expectations for the recession in 2023? What is housing’s expected role in the recession?
Duncan: We’ve kept our position that we’ve had since last April, which is that there will be a mild recession. Mild in part because of the housing sector. The supply problem hasn’t been fixed. It’s pretty much on [builders'] backs, because boomers are aging in place, and Gen Xers are locked in at 2.5% to 4% mortgages and are unlikely to go anywhere anytime soon. That means that additions to supply will largely come from construction. The millennials are still a couple years away from the peak median age for first-time home buyers. There’s still strong pent-up demand in that space.
On the consumer side, while employment is still really strong, the usage of credit cards has picked up, saving rates have fallen, there is still some excess savings—by which we mean the amount of savings measured by pre-pandemic levels. In higher-income households, they still have higher levels of savings than they would have had pre-pandemic. They’ve held on to some of the transfers that came through during the pandemic. In general, retail sales were down. The Conference Board Leading Economic Index has been down for several months in a row. The yield curve is seriously inverted.
To set it up for housing to lead the economy out of the recession: Builders, if they see rates come down, they see the possibility that pent-up demand will start to activate. And they’ll build to that, and we’ll see a pickup in construction employment.
Palim: Historically, 2008 was a very unique recession focused on housing due to weaknesses in the credit underwriting and some overbuilding prior to the downturn. Most recessions are not like that. As the Fed tightens, you see housing and the interest rate–sensitive components of the economy—durables, housing-related appliances, and business investments—will react. Housing is in a recession with declining home sales in both existing and new that’s gone on in the past year. Car sales were held back because of the supply chain, but you’re seeing a weakness in car sales. With the latest GDP report, you’re seeing weaknesses in business fixed investment. [Also], the inverted yield curve. All of those are classic signs of a downturn.
BUILDER: What are Fannie Mae’s expectations of the Federal Reserve’s actions related to inflation—are further rate hikes to the Federal Funds Target Rate expected in 2023?
Duncan: It is the case that the Fed has seen the turn in headline inflation and that it is in decline. We would expect inflation would continue to decline. We do expect a quarter-point increase in the [Feb. 1] meeting. Perhaps another one beyond that. There is some data that suggests that they have never stopped raising rates while the Fed Funds target was still below the headline rate of inflation. They are still not there. But it is a combination of their increases and how fast does headline inflation come down to the point where they determine they’ve done enough. We’re not there yet, but they will have two more months of data by the time of their next meeting. At present, we think there will be another quarter-point increase then. One thing related to housing is that the housing component of core inflation lags. House prices have begun to decline, and rents declined in the fourth quarter. We expect them to decline for another quarter or two. That’s going to turn that component of the inflation measure. It depends on what they think about that. Should we in anticipation of that stop tightening because we know it’s going to come down or not?
It’s so dependent today on the perspective of Fed chair Jerome Powell and whether the rest of the Federal Open Market Committee members share his perspective. Those two things are really key, and the ability to model those things is limiting, so you have to make a bet. The market is betting that they’ll be easing in the second half of 2023. It’s risky to go against the market. Our forecast contains that.
One of the things I believe he’d like to do is to expunge what has been called the “Greenspan put,” it’s really probably the “Greenspan-Bernanke-Yellen put,” in which Alan Greenspan during his tenure as Fed chair said raise rates slowly on the front end, but you can always cut them clearly on the back end to cool the economy. The market has built that in. They respond that every indicator that the Fed is having success is a reason to celebrate that the Fed is going to ease now. Powell has been saying at press conferences: It doesn’t matter how fast we go, it does matter where we stop, and we’ll probably be there longer than you think. To me, that is saying, 'I don’t want the Greenspan put out there.' The second thing is that I think he may have some view that when [former Fed chair Paul] Volcker took on inflation in 1979, he got a recession for about seven months in 1980, and the economy eased a bit in growth. Then growth picked up, but so did inflation, so they had to tighten again and got a serious recession the second time. He may be working to try to prevent there being a double dip [recession].
Palim: For [builders], perhaps the most important part of the outlook in terms of the business planning is that we have a mild recession and unemployment stays below 6%. Which means all those people don’t lose their jobs and potential customers can continue to do reasonably well. Second and more important, with the dip in mortgage rates down to 3%, there was a huge lock-in effect for existing homeowners. Most typical new-home buyers were move-up buyers. In our minds, there is going to be a shift in the composition of who the buyers of new homes are during the recovery. There are still going to be many households that are existing households that have the 3% or 4% mortgages and will not want to give them up. Builders who figure out how to pivot their product mix to satisfy a first-time home buyer will likely have an advantage. First-time home buyers typically buy the house of an existing owner who is moving up. But we think that stock is going to be held for longer, and it will be harder to get those existing homeowners to release their homes. So, the builders who focus on a product that appeals to first-time home buyers would have a nice business opportunity there.
BUILDER: What are metrics to watch during 2023 to keep tabs on the development of the recession and overall economy?
Palim: One thing that is not that fashionable to watch anymore is the money supply numbers. The M2 really went up with the surge in spending in response to the pandemic and the Fed’s accommodation of that. M2 has dropped pretty dramatically. Watching what’s happening with the money aggregates and the credit aggregates will be important. The Fed has raised rates pretty aggressively to catch up. Inflation got out ahead of them. What the impact will be on the credit system and on business is uncertain. I would watch those things.
