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Review of all things Real Estate: Fighting inflation

If the game of chicken over the debt ceiling leads the U.S. to default on its obligations, mortgage rates could leap above 8%, Zillow recently warned. Even if a debt ceiling crisis is avoided, there’s talk the Federal Reserve may keep raising rates to fight inflation.

Bond market investors always look ahead, so mortgage rates are on the ascent and approaching 2023 highs. With would-be homebuyers already coping with inventory shortages, purchase loan requests dropped 4% last week and were off 30% from a year ago.

Housing is outperforming, but recession may still be in the cards

By Matt Carter

Inflation remains stubborn, but Federal Reserve rate hikes and tightening bank lending standards are likely to lead to a “modest recession” later this year, Fannie Mae economists said. In the meantime, housing continues to outperform expectations this year, even if “extraordinarily tight” inventories of existing homes has shifted demand toward the new home market.

Strength in new home construction, auto sales and labor markets means there’s even a risk that the Fed will continue raising rates if inflation doesn’t cool, and Fannie Mae economists no longer expect mortgage rates to fall below 6% this year, as forecast in April.

“We maintain our view that a modest recession will begin in the second half of 2023,” Fannie Mae Chief Economist Doug Duncan said. “Housing continues to outperform our expectations, and we expect that its relative strength will help kickstart the economy into expanding again in 2024.”

April’s strong job numbers and continued pressure on wages remain inconsistent with the Fed’s long-term goal of bringing inflation back down to 2%. That raises the possibility that instead of pausing interest rate hikes or even bringing rates back down to head off a recession, as many bond market investors expect, the Fed will be forced to raise rates again.

“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 – although the Fed has adopted a wait-and-see approach,” Duncan said.

At an economic conference Friday, Federal Reserve Chair Jerome Powell repeated past assurances that future rate decisions will be based on the latest inflation data.

Tightened bank lending standards driven by the recent failures of Silicon Valley Bank, Signature Bank and First Republic Bank could help the Fed achieve its inflation-fighting goals.

Turmoil in the banking sector is “contributing to tighter credit conditions and are likely to weigh on economic growth, hiring and inflation,” Powell said, meaning the federal funds rate “may not need to rise as much as it would have to achieve our goals.”

But historically, monetary tightening cycles typically end in a recession, particularly when the Fed is reacting to inflation rather than moving proactively to preempt it. In commentary accompanying their May forecast.

Many bond market investors expect the Fed to reverse course and begin lowering rates this year as the economy cools. But Fannie Mae economists say the Fed is likely to keep interest rates elevated until it sees evidence that the tightening already implemented is moving the numbers in the right direction.

“We believe the Fed is unlikely to be convinced that inflation is under control until the labor market softens sufficiently, so we think it probable that policy will remain tight until a contraction is under way,” Fannie Mae economists said.

While Fannie Mae forecasters still expect mortgage rates to trend down this year and next, they’re projecting a gentler downward glidepath. In April, Fannie Mae economists were envisioning that rates on 30-year fixed-rate mortgages would dip below 6% in the third quarter of this year and fall to an average of 5.7% during the fourth quarter of 2023.

Now, with inflation still problematic, Fannie Mae economists don’t see mortgage rates dipping below 6% until the first quarter of 2024. The latest forecast is for rates to dip to an average of 5.4% during the fourth quarter of 2024, instead of 5.2% in April’s forecast.

Economists at the Mortgage Bankers Association, who forecast in April that mortgage rates would dip below 5% next year, hadn’t yet issued their May forecast.

Strength in new home sales, which have been trending upward since Fannie Mae economists expect sales of existing homes will likely remain subdued for the rest of the year, thanks to a lack of inventory and persistence of the “lock-in effect,” which discourages existing homeowners with low mortgage rates from putting their homes on the market.

Fannie Mae economists made only minor adjustments to their forecast for existing home sales from April to May, saying they expect 2023 sales to decline by 16% from last year to 4.217 million, before rebounding 4% next year to 4.381 million.

With mortgage rates falling more gradually than expected, Fannie Mae economists downgraded their forecast for 2023 refinancings by $21 billion from April to $291 billion. While refis are expected to rebound by 92% next year to $558 billion, that’s $26 billion less than forecast in April – and a drop in the bucket when compared to the $2.67 trillion in mortgages refinanced when rates hit record lows in 2021.

Purchase mortgage originations are expected to track down with home sales and cooling home price appreciation, falling 18% this year to $1.359 trillion. But if home sales rebound next year as forecast, purchase mortgage originations are expected to rebound by 8% next year to $1.468 trillion


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