Fannie Mae says U.S. still on track for modest recession

Fannie Mae still expects a modest recession to start in the first quarter of 2023 as it downgraded its gross domestic product outlook for that year.

However, GDP will end this year unchanged from 2021, the November forecast said, slightly improved from Fannie Mae's -0.1% prediction one month ago.

Housing is still expected to lead the nation into recession, Doug Duncan, Fannie Mae's chief economist said. For the full year of 2023, he now expects -0.6% GDP, versus -0.5% in the October outlook. GDP will not turn positive until the fourth quarter of 2023.

"Higher interest rates have ignited the typical reduction in residential fixed investment, which historically has led into either an economic slowdown or recession," Duncan said. "From our perspective, the good news is that demographics remain favorable for housing, so the sector appears well-positioned to help lead the economy out of what we expect will be a brief recession."

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Even though the labor markets are still strong, Duncan stuck with his prediction for a recession, noting that employment is a lagging indicator.

"Of course, the most notable difference in the labor market between past recessions and current conditions is the level of labor market gains, which are more than triple the average of past recessions," Duncan said. But sentiment indicators like the National Federation of Independent Business Small Business Optimism Index are trending downward, which is not good news for the employment picture.

But the better-than-expected October Consumer Price Index report of an annual gain of 7.7% — which sparked a large drop in mortgage rates last week — is a sign that inflation likely peaked, Duncan added.

Meanwhile, the current housing market downturn is a result of the biggest and fastest increase in mortgage rates and this led to the sharp reduction in volume and revenue, making this something the business had never dealt with before, claimed Jim Cameron, a senior partner at Stratmor Group, in an article in its November Insights Report.

"While most senior executives have managed their way through multiple downturns in the mortgage business, the universal sentiment is that 'this one feels different,'" Cameron said. "That's because it is different!"

Right now, the mortgage industry still has an unprecedented amount of excess origination capacity, and many lenders will need to sell or otherwise won't survive the downturn, he said.

"Yet there is some light at the end of the tunnel and there are some positive aspects to this cycle, absent a major recession. The duration of the downturn may be shorter than past down markets," Cameron said. That is because nonbank mortgage originators have a historically high market share right now, at 81%.

And they are more motivated than banks to reduce excess capacity.

"While it is true that many nonbanks entered this downturn with a large war chest of cash and capital, this is more than offset by the impact of warehouse and investor covenants, which are causing lenders to move expeditiously to cut costs," Cameron said. "In short, while this downturn is very painful, perhaps we will get through it faster."

But affordability will likely remain a drag on the housing market's potential until buying power recovers, which is unlikely in the foreseeable future, said First American Chief Economist Mark Fleming.

"House prices have already begun to adjust to the reality of higher mortgage rates, which will help bring more balance to the housing market heading into 2023," Fleming said

His trend to watch in 2023 is if mortgage rates go higher and if so, by how much.

"The housing market, once adjusted to the new normal of higher mortgage rates, will benefit from continued strong demographic-driven demand relative to an overall, long-run shortage of supply," Fleming said. "Based on current dynamics, it appears the housing market may begin to stabilize in 2023."

Fannie Mae's November forecast calls for $2.34 trillion of mortgage originations this year, with $1.64 trillion coming from purchase activity.

That is a slight increase from October's outlook for $2.3 trillion, with $1.63 trillion in purchase loans.

But Duncan cut his 2023 projection to $1.71 trillion from $1.74 trillion a month ago. Purchase volume was changed marginally, to $1.337 trillion from $1.343 trillion.

That is because Duncan cut his 2023 existing home sales forecast to 3.897 million units on a seasonally adjusted annualized rate in November from 3.928 million units for the October outlook.

Duncan issued his first 2024 forecast, which expects existing home sales to rebound and increase 18% over 2023 to 4.597 units.

That will bring originations in 2024 up to $2.11 trillion, of which $1.57 trillion will be purchase mortgages.

"Household financial obligations and debt service ratios are much lower than average in 2022, and certainly much lower than when we entered the Great Recession of 2007 and 2008," Stratmor's Cameron said. "This is good news for lenders — as we emerge from this mortgage market downturn, borrowers and prospective borrowers will be in a better position to qualify for mortgages and to make their payments once they close their loans."

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