Fannie Mae expects 2023 recession from Fed’s faltering ‘fix’
By Larry StewartMay 24, 2023
Unpredictable economic dynamics may cloud timing forecasts, but Fannie Mae’s Economic and Strategic Research (ESR) Group sounds pretty convinced there will be a mild recession in the last half of 2023.
Otherwise known as the Federal National Mortgage Association (FNMA), Fannie Mae is a government-sponsored enterprise that purchases mortgages from smaller banks or credit unions and guarantees them for low-to-median income borrowers to keep housing affordable. Their ESR Group’s monthly commentary makes clear that the group expects the housing market to soften the upcoming downturn.
“Housing remains exhibit number one for why we expect the recession to be modest,” said Doug Duncan, Senior Vice President and Chief Economist, Fannie Mae. “It continues to outperform our expectations, and we expect that its relative strength will help kickstart the economy into expanding again in 2024.”
‘Disrupted’ pre-recession fundamentals
Fannie Mae’s ESR Group points out that consumer spending remains unsustainably high compared to incomes and that recession typically follows a tightening of monetary policy. But the group also notes that the typical ways monetary policy helps slow the economy may be disrupted.
“Inflation has been resistant to Fed efforts to drive it down, and we view the risks to our baseline forecast as tilted toward more tightening rather than easing,” said Duncan. “Although, for the moment, the Fed has adopted a wait-and-see approach.”
Evidence of this particular economy’s resistance to customary monetary-policy levers include recent increases in new auto sales, which the ESR Group says is the result of improving supply conditions and a more upbeat outlook from homebuilders. Fannie Mae’s statement on this new analysis says its research group still believes a modest recession is the likeliest outcome – and that its timing remains the principal outstanding question – as the Fed is likely to continue applying the disrupted tool of higher interest rates if inflation does not subside.
Unique housing dynamics
Existing home sales have been largely in line with the ESR Group’s recent forecasts for further gradual declines throughout the year due to affordability constraints and an extraordinarily tight inventory of existing homes for sale.
One thing constricting the existing-home inventory is the so-called “lock-in effect,” in which existing homeowners are decide not to list their homes for sale because their existing mortgage rate is well below current market rates. The lock-in has shifted housing demand further toward new homes, bolstering builder optimism and the group’s single-family starts forecast. But Fannie Mae continues to expect a significant slowdown in multifamily housing starts later this year resulting from tightening credit conditions, slower rent growth, and higher vacancy rates.
“There are select data available to support several alternative views of the path of the economy,” said Duncan, “Though unusual dynamics in the current economic cycle continue to complicate forecasting the exact timing, we maintain our view that a modest recession will begin in the second half of 2023.”
Does fixing inflation have to cost jobs?
Despite its current wait-and-see posture, it appears Federal Reserve chairman Jerome Powell is leaning toward continued tightening of monetary policy at the risk of precipitating a downturn. Waiting and seeing has a risk. Leaving inflation at its current levels for an extended period tends to raise long-term inflation expectations, which leads to slowly increasing inflation.
Reuters reports Powell’s remarks at last week’s U.S. central-bank research conference that foreshadow a return to interest-rate increases:
“I don’t think labor market slack was a particularly important feature of inflation when it first spiked in spring of 2021,” Powell said. “By contrast, I do think that labor market slack is likely to be an increasingly important factor in inflation going forward,” reiterating his observation that price increases are proving most stubborn in service industries where “labor costs are a high proportion of total costs.”
But not all Fed policymakers depend so heavily on stifling jobs to corral inflation. Reuters reports that Chicago Fed President Austan Goolsbee and others have argued that wage gains reflect past price hikes, rather than previewing future price increases. Some “feel a point of steady ‘disinflation’ may be close, and hinges only on families and businesses spending final doses of pandemic-era cash.”
Atlanta Fed economists have pointed out that after COVID-19 pandemic years in which businesses saw outsized – often record-breaking – profits, there is room for wages to grow through a decline in business margins rather than rising prices.