Inflation is Slowing, But Fully Quelling It Will Be Tough

WASHINGTON, DC – While the latest data on inflation has provided reason for optimism, less favorable base effects are likely to slow further progress in reducing annual inflation to the preferred 2-percent target, according to the July 2023 commentary from the Fannie Mae (FNMA/OTCQB) Economic and Strategic Research (ESR) Group. Given the low rate of productivity gains, wage growth appears to remain too high for inflation to near its target rate anytime soon, and so the ESR Group is forecasting another rate hike later this month and even tighter monetary policy through the end of the year. The ESR Group expects the Consumer Price Index, on an annual basis, to end the year around 3.1 percent, with the core index around 4.3 percent. Following an unusually large upward revision to first quarter 2023 gross domestic product, this month the ESR Group upgraded its expectations for economic growth in 2023 by a full percentage point to 1.1%. However, while noting that the probability of a "soft landing" may have increased of late, the ESR Group continues to expect a modest recession beginning in the fourth quarter of 2023 or the first quarter of 2024.

An extremely limited number of existing homes available for sale continues to be the defining feature of today's housing market, according to the ESR Group. While total home sales remain near the lowest annual level since 2009, this is not due to lack of demand. Rather, the ongoing lack of inventory, the extent of which exceeded the ESR Group's earlier expectations, has resulted in significantly stronger home price appreciation than previously anticipated. Dynamics in the existing sales market have been highly supportive of new construction, though, and the ESR Group has significantly upgraded its single-family starts forecast. Still, given the ESR Group's expectation of slowing economic activity through the end of the year and into 2024, it continues to anticipate slowing home price growth and a slower pace of starts in 2024.

"The Fed's policy tightening in an effort to quell inflation is probably close to finished, although their guidance is really more current than forward, and incoming data will be determinant," said Doug Duncan, Senior Vice President and Chief Economist, Fannie Mae. "The decline in headline inflation is encouraging, but year-over-year measures will work against further progress in the second half of 2023. Thus, we expect the Federal Reserve will stick to 'higher-for-longer' policy after one or two more quarter-point increases, until they conclude that the core inflation rate is sustainably at their 2-percent target. Putting aside any temporary volatility, we expect mortgage rates to stay higher as well. While spreads have come in a bit recently, they remain well above longer-term levels and that means rates for consumers will likely stay elevated."

Duncan continued: "We began discussing our expectations of a supply shortage in late 2014, and it remains front and center in the housing market in 2023. The supply of existing homes is near the 2009 crisis low, and it's showing no signs of easing. This puts the onus on homebuilders and can be seen in the construction data. There is uncertainty about the real financial capability of households enabling continued support for the economy and housing. Estimates of 'excess saving' vary widely in accordance with what is assumed to be a 'normal' saving rate. The recent difficulties in the banking sector have led to some credit constraint, usually a harbinger of slowdown in economic activity. As we noted in our April 2022 forecast, whether there is a mild recession (our base case) or a soft landing, the supply issues in housing will provide a downside cushion for economic activity. That is playing out quite close to forecast on existing homes, but new construction has been even more supportive than we expected."

Visit the Economic & Strategic Research site at fanniemae.com to read the full July 2023 Economic Outlook, including the Economic Developments Commentary, Economic Forecast, Housing Forecast, and Multifamily Market Commentary. To receive e-mail updates with other housing market research from Fannie Mae's Economic & Strategic Research Group, please click here.

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae’s Economic & Strategic Research (ESR) group included in these materials should not be construed as indicating Fannie Mae’s business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR Group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.

About the ESR Group
Fannie Mae’s Economic and Strategic Research Group, led by Chief Economist Doug Duncan, studies current data, analyzes historical and emerging trends, and conducts surveys of consumer and mortgage lender groups to provide forecasts and analyses on the economy, housing, and mortgage markets. The ESR Group was awarded the prestigious 2022 Lawrence R. Klein Award for Blue Chip Forecast Accuracy based on the accuracy of its macroeconomic forecasts published over the 4-year period from 2018 to 2021.