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Economic & Housing Outlook

COVID Back in Spotlight, But Continued Growth Expected

August 19, 2021

We revised downward our forecast for 2021 real gross domestic product (GDP) from 7.0 percent to 6.3 percent on a fourth quarter-over-fourth quarter (Q4/Q4) basis, with a partially offsetting upgrade to 2022’s expected growth rate to 3.2 percent from 2.8 percent. The slower projected pace is due in part to a weaker-than-anticipated second quarter GDP figure and in part to a modestly weaker second half outlook. With consumer spending now at levels consistent with the pre-COVID trend and the impact of government stimulus waning, we believe future growth is heavily dependent on a combination of businesses rebuilding depleted inventories and consumer spending continuing to shift away from goods and into services. While we expect solid GDP growth in the coming quarters as these trends materialize, behavioral changes related to the Delta variant of COVID-19 and persistently strained supply chains will likely weigh more heavily on the speed of recovery than we had previously forecast. Our inflation outlook was adjusted slightly, but we continue to expect growing broader inflationary pressures from wage and home price growth to partially offset the transitory factors driving recent inflation, many of which have likely peaked or will soon. On an annual basis, we forecast the Consumer Price Index (CPI) to remain around 5.0 percent at year-end 2021. While substantial deceleration is expected to follow, inflation is forecast to remain elevated through the end of 2022, with core CPI ending the year above 3 percent. 

We downgraded our home sales forecast for the second half of 2021, driven by a weaker outlook for the sale of new homes, largely due to continued supply constraints impacting homebuilders. This was partially offset by a modest upward revision to existing home sales based on incoming data and the recent decline in mortgage rates. However, we expect continued scarcity in listings to dampen potential sales, and therefore some continued downward movement over the third quarter. We now expect 2021 total home sales to increase 3.1 percent from 2020, compared to 3.8 percent in our July forecast. For new construction, we forecast 2021 housing starts to be 16.9 percent higher than in 2020, down from a 17.7 percent gain previously. A modest downward revision to single-family starts was partially offset by an upgrade to multifamily construction. Largely due to a lower interest rate outlook, our 2021 mortgage originations forecast was upgraded to $4.4 trillion, up from $4.2 trillion. Refinance originations accounted for most of the upgrade. Our forecast of 2022 originations ticked upward to $3.3 trillion from a prior $3.2 trillion. 

COVID Developments and Supply Shortages Remain Heightened Risks
In our view, the two principal short-term risks to the forecast are: 1) the future trajectory of and behavioral responses to the recent growth in COVID-19 cases; and 2) how quickly supply chain disruptions and labor market tightness will resolve. For now, we believe the former will only lead to a modest drag on activity, while the latter will likely see significant improvement, though both views face serious risks. Additionally, while we believe underlying inflationary pressures are building, the risk of even stronger inflation is possible. If current labor market tightness does not ease in coming quarters and longer-term inflationary expectations increase, a meaningful wage-price spiral could develop. If this occurs, the Fed may tighten monetary policy earlier and/or more aggressively than currently anticipated. This would likely drag on growth, housing, and mortgage activity. Other housing-specific risks include the permanence of shifts in recent regional migration patterns, the impact on home sales and prices from the expiration of mortgage forbearance programs, and the duration of housing construction supply chain problems.

Alternatively, upside risks include stronger than anticipated productivity growth, leading to less inflation and greater real wage growth, and elevated household savings driving more robust consumption than forecast. Further, we have not yet incorporated the Senate-passed infrastructure bill into our outlook due to uncertainty over details and timing of the final bill, nor have we assumed any additional fiscal legislation. Still, due to a limited net change in expenditures through 2022 and that productive benefits of infrastructure are typically realized over the longer run, we expect only a minimal impact on the near-term growth outlook. In contrast, the much larger proposed federal budget reconciliation bill could have meaningful impacts on growth, inflation, and interest rates, depending on final details.

Our Baseline View on the Current COVID-19 Wave
We expect the recent COVID surge will drag modestly on consumers’ services consumption in the near term and modestly worsen supply chain disruptions abroad, but it should not prevent solid growth in Q3. Data is limited, but there are some early signs of modest behavioral changes on the part of consumers and firms. A high frequency measure of restaurant reservations has recently pulled back slightly, and several airlines are reporting an uptick in customer flight cancellations. The most recent measure of the University of Michigan Consumer Confidence survey also declined dramatically, suggesting the COVID upswing is weighing on sentiment. Anecdotally, reports of employers delaying reentry to office work and cancelling in-person events and conferences are growing. 

 Cases in the US appear to be a month behind cases in the UK suggesting a slowdown could be near

In Britain, where vaccination rates are comparable to the U.S. and where COVID cases surged about 40 days prior to the American outbreak, cases have meaningfully declined, providing hope the U.S wave may be nearing its peak.  As of this writing, some of the states that first saw surges, such as Missouri and Arkansas, are experiencing daily case flattening or declines, and while hospitalizations and fatalities have risen, they remain far below the relative rates versus cases seen last year. Therefore, while modest measures are being reimplemented, we do not anticipate strict lock downs or widespread social distancing measures and are assuming any softness in consumer activity will be temporary.

Inventory Restocking, Labor Market Easing Key to Growth Story
Compared to our prior forecast of 8.1 percent annualized growth, second quarter GDP came in weaker at 6.4 percent. Still, this was enough growth to push output past the pre-COVID level.  Despite the relative softness, both consumer spending and business fixed investment were stronger than we had anticipated, suggesting that the underlying demand recovery remained robust. The miss was driven by weaker state and local government spending, which can be attributed to a slower utilization of stimulus bill funding and a larger-than-expected decline in business inventory investment. The former is likely to be accounted for in coming quarters; the latter points to the ongoing difficulties firms are experiencing in maintaining desired inventory levels. Typically, inventory investment softness over a given quarter relative to final sales leads to an expectation of even stronger inventory gains in the subsequent quarters. However, given ongoing supply chain difficulties, we have pared back our expectation for the coming inventory rebound. Still, the most recent monthly data suggest that inventories will contribute strongly to growth in the third quarter. We expect restocking, especially as consumption shifts to services, alleviating goods demand to be key to second half growth. 

 Rise in firms facing low inventories suggests that firms will need to restock

On top of supply chain disruptions, labor market tightness persists. Business surveys continue to report a near-record share of firms finding it difficult to fill positions. Meanwhile, job openings in June jumped 590,000 to 10.1 million, the highest on record. We expect labor market tightness to alleviate going forward as expanded unemployment benefits expire by September, schools reopen, and, hopefully, COVID worries meaningfully subside. The most recent employment report was encouraging, showing a gain of 943,000 jobs in July. Still, there is a risk that the strong report was driven largely by a statistical anomaly. Net hiring is usually slow over the month of July, so the seasonally adjusted gain reflected fewer job reductions than is typical for the month, rather than an actual rise in employment. Given that the remaining service sectors that have not yet fully recovered tend to be labor intensive, our current growth outlook requires strong and sustained payroll employment gains. Therefore, a lot of attention will be directed toward the August employment report and whether it confirms a strengthening employment trend.

Transitory Inflation Has Likely Peaked Though Underlying Pressure Building
In line with our expectations, the CPI rose 0.5 percent over the month of July and was up 5.4 percent on an annual basis. The core index, which removes volatile food and energy prices, rose by a lesser 0.3 percent (up 4.3 percent annually). While still high relative to the pre-COVID period, the monthly change decelerated significantly from the prior three months. Many of the transitory factors driving the bulk of recent eye-popping price gains moderated sharply. Most notably, the price of used autos, which surged by over 10 percent in June, rose by a much lesser 0.2 percent. A common measure of wholesale used car prices suggests a future modest pullback in retail prices will soon occur. This outright decline would drag on the topline CPI. While price declines are not expected in some of the other recently surging categories related to reopening, such as airline tickets, hotel rooms, and auto insurance, many are now nearing levels consistent with their pre-COVID growth trends; therefore we believe the “catch-up” period is likely to end soon. Still, other sectors continue to face upward pressure due to supply disruptions, as evidenced by the Producer Price Index (PPI) continuing to surge, rising 1.0 percent in July and 7.8 percent annually. However, we believe this, too, will eventually moderate.

Yet, as these transitory factors wane, we expect longer-lasting pressures to continue to build, partially replacing recent drivers of heightened inflation. Underlying wage pressure is growing, at least part of which is likely to be passed on to consumers as higher prices. The NFIB Survey of Small Businesses continues to report a near-record high share of firms raising or intending to raise compensation and sales prices. Further, prices in the food service and hospitality sectors, which have experienced some of the steepest wage increases, have moved above their pre-COVID trend. While we expect labor market tightness to significantly ease as aforementioned temporary factors pass, a significant portion of the labor force has likely left via early retirement or for other long-term reasons.  Therefore, returning to the pre-COVID employment trend would likely require higher wage rates. If such wage increases are not accompanied by higher productivity, this would exert upward pressure on inflation.

Furthermore, as we’ve discussed in our previous commentaries, housing-related inflation is also likely to become a major driver of measured inflation through at least 2022. Due to survey technicalities and standard rental leases being set for a year, changes in the CPI measures of rents and Owner’s Equivalent Rent (OER) tend to significantly lag changes in home prices and market rents. Due to strong house price gains and the more recent jump in market asking rents, acceleration is expected to occur within these large subcategories of the CPI over the next year.

Home Sales Still Being Held Back by Lack of Supply
Existing home sales were somewhat stronger in June than expected, increasing 1.4 percent over the month to an annualized pace of 5.86 million. However, given a further decline in pending home sales, which lead closings by 30-45 days on average, as well as declines in purchase mortgage applications, the recent downward trend in sales seems likely to continue in the near term. Demand is likely softening a bit as last year’s pulling forward of purchases wanes and rising home prices increasingly weigh on affordability, but we continue to view the lack of homes for sale as the primary constraint. New sale listings have increased somewhat in recent months to approximately the same pace as in 2019, but this rate is still too low to sustain the current sales pace, which is currently about 10 percent higher than the mid-2019 sales rate. Months’ supply came in at 2.6, the lowest ever reading for the month of June, another indicator of historically tight inventories. We expect sales to trend downward before beginning to move up slightly toward the end of the year.  

 New for sale listings sit just above levels seen in 2020 and 2019

We also expect a modest increase in the listings pace as the year progresses. While we are not expecting a high level of foreclosures, the expiration of the foreclosure moratorium is likely to lead to some additional listings. Additionally, we forecast an increase in new construction, which should increase supply and potentially induce more move-up buyers to list their existing homes. Still, we expect tight inventories to persist. The past two months of declining mortgages rates would normally lead us to expect a greater increase in home sales over the latter half of the year, as rate changes typically induce more homebuying. But the historically low level of inventory for sale suggests that any rate-related increase in sales will be muted due to the inadequacy of listings needed to fulfill higher buyer demand. This softer sales response also suggests more upward pressure on prices. Therefore, we upgraded our existing home sales forecast only slightly. We now project existing home sales to total 5.86 million in 2021, compared to our prior forecast of 5.83 million.

Home prices continue to show little evidence of slowing down. Prices rose 18.0 percent from a year prior in May, according to the FHFA Purchase-Only Home Price Index. This was the fastest annual pace of growth on record since the series began in 1992. As affordability increasingly gets stretched, we expect softening in price appreciation, even if demand remains robust. The July reading of the Fannie Mae Home Purchase Sentiment Index® (HPSI) fell 3.9 points, and it represented the fourth consecutive month that a record-low share of respondents said it was a good time to buy a home. High prices and a lack of inventories for sale remained the top reasons cited for homebuying pessimism. 

 Growing share of homes for sale but not yet started points to large construction backlog

New home sales fell considerably in June, falling 6.6 percent to 676,000, the lowest reading since April 2020. This was far weaker than we had anticipated, though we believe this weakness to be primarily driven by homebuilders turning down orders to a greater degree than we had anticipated in order to give themselves time to catch up on construction backlogs. In their Q2 earnings calls, many publicly traded builders spoke of throttling back their order books in the face of supply disruptions, high materials costs, and labor scarcity. Consistent with this view, even with a softer sales pace in June, the share of sales that sold but had not yet started hit a record high. We expect sales to be subdued in the near term as this dynamic takes some time to play out, but eventually builders will work through their backlogs and start taking more orders. Lumber price futures are now down about 70 percent from their April peak, and supply side disruptions and labor scarcity are expected to lessen going forward. Continued tight inventories of existing homes for sale should continue to drive demand for new homes. For now, the question is whether homebuilders will be able to meet that demand. While we downgraded our 2021 new home sales forecast considerably (801,000 in our latest forecast, compared to 874,000 last month), we anticipate that sales will start moving upward in the coming months. While single-family housing starts were also somewhat weaker in June than we had expected, they remained comparatively strong relative to sales, consistent with homebuilders working to catch up. We made only a modest downward revision to our single-family housing starts forecast.

Multifamily construction continued to exhibit strength in June moving up by 6.2 percent to 483,000. While multifamily rent levels remain below the pre-COVID peak in a handful of large and high-cost metro areas, national-level rent measures show levels higher than pre-COVID. Rent growth has also been exceptionally robust in recent months while vacancy rates remain low. Demand for apartments has been particularly strong in many less expensive metros in the South and non-coastal West, as well as many suburban areas. We meaningfully upgraded our multifamily starts forecast and now project multifamily housing starts to be 460,000 in 2021, up from 444,000 previously.

For more on multifamily market conditions, please see the August 2021 Multifamily Economic and Market Commentary.

Lower Interest Rates Lead to More Refinance Originations
Recent concerns over the spread of the Delta variant, coupled with a weaker than expected Q2 GDP number, coincided with the 10-year Treasury yield briefly falling to as low as 1.15 percent in early August. These recent movements suggest to us that market participants have become warier of the pace of continued global growth. Still, the 10-year yield rebounded on the strong July jobs reports and has since increased; at the time of this writing, the 10-year reached 1.29 percent and the 30-year fixed mortgage rate was at 2.87 percent. We currently have mortgage rates projected to end 2021 at 2.9 percent in Q4, down from 3.1 percent in last month’s forecast.

Barring any surprises, we believe rates will likely stabilize near current levels over coming weeks as markets await Federal Open Market Committee (FOMC) Chairman Jerome Powell’s end-of-August speech at Jackson Hole, where he may signal an intention to begin tapering Fed asset purchases. In past months, the FOMC has been adamant that “substantial progress” in terms of the labor market recovery needed to be made in order to change their policy stance. Following the July FOMC meeting, the FOMC statement highlighted that some progress had been made toward the FOMC’s goals, a shift in language that, one week later, was supported by the July jobs report. While there is still room for the labor market to recover, we expect further strength in job gains as well as continued robust inflation numbers may lead to the FOMC formally announcing the beginning of asset purchase tapering by the end of the year.

We have upgraded our refinance originations forecast because of the lower expected rate environment, with refinance origination volume projected to be $2.5 trillion in 2021, a $143 billion increase from last month’s forecast.  In 2022, we project volumes to be $1.3 trillion, $72 billion higher than last month but a decline of 47 percent from 2021. At the current interest rate level, we estimate that around 51 percent of all outstanding mortgage balances have at least a 50-basis point incentive to refinance, up slightly from 48 percent in last month’s forecast.   

As with our sales forecast, we have also made minor revisions to our purchase originations outlook this month. In particular, purchase volumes are now projected to be $10 billion higher in 2021 and $2 billion higher in 2022 compared to last month’s forecast. We expect purchase volumes to total $1.8 trillion in 2021, growing at a 12 percent pace over 2020 volumes, followed by a further 7 percent growth in 2022 to $2.0 trillion.

Economic & Strategic Research (ESR) Group
August 13, 2021

For a snapshot of macroeconomic and housing data between the monthly forecasts, please read ESR’s Economic and Housing Weekly Notes.

Data sources for charts: John Hopkins CSSE, National Federation of Independent Business, Census Bureau, CoreLogic Multiple Listings Service, Fannie Mae ESR Analysis

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.

ESR Macroeconomic Forecast Team

  • Doug Duncan, SVP and Chief Economist
  • Mark Palim, VP and Deputy Chief Economist
  • Eric Brescia, Economics Manager
  • Nick Embrey, Economist
  • Nathaniel Drake, Economic Analyst
  • Richard Goyette, Economic Analyst
  • Rebekah Gutierrez, Financial Analyst