Economic Developments - December 2023

2023 Unfolded Better than Expected, but 2024 Still Poised to Slow

The past year began with an inverted yield curve, rising interest rates, waning fiscal stimulus, a slowdown in both housing construction and home price growth, and, in March, bank failures. A 2023 recession appeared to be developing. However, as the year progressed, consumer spending remained resilient and acute banking stress subsided while home prices rebounded. Continued economic resilience has surprised many forecasters this year and led to financial markets backpedaling multiple times on the pricing of impending Federal Reserve “pivots,” ultimately helping drive a rise in longer-term interest rates, including mortgage rates, to a 23-year high by October. Since that peak, however, longer-term interest rates have fallen sharply recently on yet another anticipation of rate cuts and slowing inflation in 2024.

Fundamentally, our long-held view that the economy would enter a recession as monetary policy tightening worked to fight inflation was based on historical business-cycle dynamics that suggested inflation was unlikely to be brought back to the Fed’s 2-percent target without a significant weakening in the labor market. While some supply chain drivers of inflation were expected to subside over time, there was evidence that services inflation associated with a tight labor market had gone beyond what was consistent with an overall 2-percent inflation target. Historically, this has only been reduced via a substantial rise in the unemployment rate.

To date, however, cooling inflation and wage growth is occurring while unemployment remains low. Compared to a year ago, the Personal Consumption Expenditure (PCE) Price Index rose 3.0 percent in October while core prices were up 3.5 percent, down from cycle-peaks of 7.1 and 5.6 percent, respectively. While core inflation in particular remains elevated on an annual basis, much of this is due to ongoing high measures of shelter inflation which lag more timely market measures of rent by 4 to 5 quarters. Currently, measures of rent growth for new tenants show slowing or even negative rent growth. As such, it is only time before this is reflected in the PCE. And inflation less shelter, whether measured by the PCE or the Consumer Price Index (CPI), is already closer to the Fed’s target than the overall measures. The question of whether inflation could be brought down without a meaningful rise in the unemployment rate appears to have been answered in the affirmative.

However, we are not yet ready to declare that the window for a recession has passed. The labor market has cooled from extremely tight conditions in 2022 to a healthy level that broadly mimics its state in 2019. In November, the economy added 199,000 jobs, an increase from October, but this was inflated by the ending of the United Auto Workers (UAW) and Screen Actors Guild (SAG) strikes. Removing the effects of the strikes from both reports would indicate job gains slowed from roughly 180,000 in October to 150,000 in November. If this pace of employment growth can be maintained, then it would be consistent with a soft landing. However, the current monetary policy stance is still restrictive, and past tightening is still working its way through the economy. Bank lending is slow, near-term indicators suggest business investment is currently sluggish, and consumer spending is still in excess of its historical relationship to incomes. Whether it results in a recession or not, we believe growth is likely to decelerate significantly over the coming 2-3 quarters.

Given the current restrictive stance, to achieve a soft landing, monetary policy will need to ease sufficiently this next year to prevent a downturn, but not reanimate inflation – a difficult balance to achieve. An uptick in average hourly earnings in November illustrates the risk that the labor market could still overheat and contribute to future inflationary pressures if monetary policy is eased prematurely. As such, we are projecting the start of fed funds rate cuts in Q2 2024, but at a cautious pace.

2023 Home Sales Will Be Lowest Since 2010, With Slow Recovery Beginning in 2024

We entered the year forecasting existing home sales to be around 4 million, a pace below most other forecasters and the lowest since 2010. While our forecast oscillated over the year along volatile mortgage rates, and our view on economic growth evolved, the sales expectation held in a narrow range. The drivers of slow sales are well known at this point: unaffordability, lock-in effects, and a lack of existing inventories freezing much of the housing market. While we believe these dynamics will slowly dissipate over time, they will remain obstacles in 2024. We forecast year total 2024 home sales to only be marginally higher than in 2023.

With that said, the extreme low point in October, where existing sales dropped to an annualized pace of 3.79 million, is likely to be at or near the low point. While October pending sales point to November sales also being low, purchase mortgage applications, as measured by the Mortgage Bankers Association, have bounced about 15 percent off their trough in November, as mortgage rates have fallen considerably. Given an expectation of further moderation in mortgage rates, we expect sales to start drifting upward. While the difference between a soft landing and a recession would have an effect on purchase demand, given current supply constraints, we see the path of future mortgage rates as being more determinative of sales.

We have long anticipated that new home construction would hold up better than what is typical in a downturn due to the fundamental shortage of housing units. This is one of the reasons why we still think the next economic downturn will be comparatively modest. However, the degree of resilience shown by new home sales and single-family starts in recent quarters in the face of mortgage rates rising to near 8 percent was unexpected. Homebuyers now appear more acclimated to higher mortgage rates then they were in 2022, as evidenced by a lower degree of order cancellations in the most recent episode of rate increases. Additionally, homebuilders who have been aided by lower materials costs and healing supply chain disruptions have been willing and able to offer concessions, including rate buydowns, to help drive sales. This trend continues into our 2024 forecast, in which we expect new home sales to decline from current levels only slightly due to a modest economic contraction.

Along with the resilience in new home sales, so too have home prices exceeded our start-of-year expectations, with prices rebounding modestly off mild declines in late 2022. Our mortgage originations outlook, being a function of home sales and home prices, tended to drift upward over the year but remained within a 9 percent band of what now appears to be the level of originations for the year.

Economic & Strategic Research (ESR) Group
December 14, 2023
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: Bureau of Economic Analysis, Bureau of Labor Statistics, Mortgage Bankers Association, Census Bureau, National Association of REALTORS, Freddie Mac, Fannie Mae

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.