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What will happen to housing market if economy hits recession or sticks ‘soft landing’? Here’s what Fannie Mae predicts

U.S. housing market is likely to stay the same regardless of the economy

SHARE What will happen to housing market if economy hits recession or sticks ‘soft landing’? Here’s what Fannie Mae predicts
Single-family houses are pictured in theROSE community in Farmington, Utah.

Single-family houses are pictured in theROSE community in Farmington on Monday, May 8, 2023.

Kristin Murphy, Deseret News

Regardless of whether the economy sticks a “soft landing” or enters a mild recession, the U.S. housing market is likely to stay the same.

That’s according to a commentary released Wednesday by Fannie Mae economists, who noted the economy is performing stronger than previously expected, but “current business cycle contours still point to an eventual downturn” as the most likely outcome.

“In short, despite strong data so far, we aren’t ready to change our recession call” in early 2024, economists wrote.

Today, high mortgage interest rates of over 7% continue to have a tight choke hold on the real estate market, chilling it from its boiling hot days during the pandemic housing rush in late 2020, 2021 and early 2022.

In its efforts to stem record inflation levels, the Federal Reserve jacked borrowing rates, which in turn scattered would-be home buyers. The 30-year fixed mortgage rate hit 7.09% in the week of Aug. 17, the highest since 2001. Meanwhile, housing affordability issues remain stark, even though home prices have tapered in areas such as the West.

Looking at the larger economic picture, Fannie Mae economists predict “further Fed fund rate hikes are off the table for now” after the latest increase in July, given decelerating inflation measures. However, “the full lagged effects of monetary policy tightening are still working their way through the economy,” and “economic growth will have to slow to a rate that is below trend for some time in order for the unemployment rate to rise sufficiently to cause wage growth to slow consistent with a 2% inflation target over the long term, but not so slow that the economy falls into a contraction.”

“Historically, this has been a very difficult balance to achieve,” economists noted.

In other words, while acknowledging “both the ‘if’ and ‘when’ of a recession are uncertain” at this time, Fannie Mae economists are continuing to predict a mild recession, “and we are now forecasting it to begin in the first half of 2024.”

“It is easy to run your forecast ship aground by underestimating the American consumer,” said Doug Duncan, Fannie Mae’s senior vice president and chief economist. “Despite reduced saving, 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.”

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

In the meantime, Fannie Mae economists also anticipate interest rates will move higher in the months ahead, predicting the economic effects of the most recent Federal Reserve rate hike have “not yet been reflected in economic data.”

Housing market predictions

What does that mean for the housing market? Due to a shortage of home availability and a lack of willing buyers and sellers, home sales will likely remain “subdued for the foreseeable future,” Fannie Mae economists predict.

“With an ongoing tight supply of existing homes for sale and the recent rise in the 30-year fixed-rate mortgage rate to around 7 percent, we expect home sales in 2023 to remain near the lowest annual level since 2009,” they wrote.

But that doesn’t mean they’re predicting a crash, either.

“Regardless of whether a soft landing is achieved over the coming year, we expect existing home sales to stay subdued and within a tight range,” Wednesday’s commentary stated. “If a recession is avoided, then ongoing limited supply of homes for sale on the market combined with continued affordability constraints and the ongoing ‘lock-in’ effect, whereby existing owners do not want to give up their current low mortgage rates, is expected to lead to a low pace of sales.”

Existing home sales fell 3.3% in June, in line with Fannie Mae economists’ predictions, and were down almost 19% from the previous year.

“Rising mortgage rates will also exert more downward pressure on sales,” economists wrote. “However, given the already very low pace of sales, we suspect that the majority of highly interest-rate-sensitive borrowers are already on the sidelines and current sales activity is being supported by less rate-sensitive buyers.” They pointed to a higher-than-normal share of cash purchases as evidence of that.

“Necessities of life events” will continue to push some sales, economists wrote, so even though there is “some downside risk to our existing home sales forecast if mortgage rates continue to rise, we see a ‘floor’ to the pace of sales and suspect the bulk of declines are already behind us.”

In Utah — one of the states in the West to see some of the most dramatic yearly home price declines, behind Idaho — home prices are still down year over year, but are up from when they appeared to bottom this winter. In June, the median single-family Salt Lake County home sold for $600,000, a nearly 8% year-over-year reduction but a 12% increase from January.

So what if a recession hits?

“Interest rates would likely pull back somewhat, lessening the lock-in effect thereby potentially boosting the number of homes available for sale,” Fannie Mae economists wrote. “However, in a recession, a weaker labor market, tighter credit, and lower consumer confidence would act as downward pressure on housing. We therefore do not anticipate a meaningful recovery in existing home sales over our forecast horizon under any of the more likely scenarios.”

What does it mean for home construction?

Homebuilders, however, have found somewhat of a foothold in the stale market, able to offer rate buydowns unlike most existing homeowners. While new home sales and construction has been “choppy” in recent months, Fannie Mae economists noted they’ve also “been on an upswing.”

Single-family housing starts jumped in July by 6.7% to a pace of 983,000 annualized units, 9.5% higher than a year ago, according to Fannie Mae. However, building permits are substantially lower, at 930,000, so “we would expect some pull-back in the near term, especially given the recent rise in mortgage rates,” they wrote.

With that said, homes are still being steadily completed, at around 1 million units annualized, so “we expect that in the absence of a recession or another sustained upward move in mortgage rates, starts would be able to converge to this level of 1 million annualized units in coming quarters as remaining order backlog issues are resolved.”

Still, rising mortgage rates may be tamping down on homebuilder confidence. The August homebuilders confidence survey, according to the National Association of Home Builders’ Housing Market Index, declined by 6 points to a level of 50, representing neutral market conditions, after seven months of upward momentum. The association also reported that the share of homebuilders using concessions or rate buydowns rose significantly, suggesting demand has pulled back.

“Since October, a mortgage rate of around 7% seems to be a psychological barrier where many buyers begin to retrench,” economists wrote. “As such, the short-term outlook for single-family home construction likely depends on whether a 7% plus mortgage rate is sustained.”

Therefore, Fannie Mae economists are predicting a “modest pullback in construction due to a slowing economy, though a similar outcome may occur if instead a soft landing is accompanied by higher for longer mortgage rates leading to slower housing construction and sales. In fact, somewhat softer housing construction and sales may be needed to make a soft landing possible.”