Recent economic data has pointed to a stronger economy than previously expected, but the current business cycle contours still point to an eventual downturn, according to the August 2023 commentary from the Fannie Mae Economic and Strategic Research (ESR) Group. Given the recent flurry of strong consumption data combined with two consecutive months of annualized Consumer Price Index measures coming close to the Fed’s 2 percent inflation target, the ESR Group notes the odds of an economic “soft landing” have increased, according to a release from Fannie Mae.

However, the full lagged effects of monetary policy tightening are still working their way through the economy, according to the ESR Group. Wage growth also likely remains too high to be consistent with 2 percent inflation over the long run, which the ESR Group believes will keep monetary policy tight.

Additionally, the ESR Group posits the recent rise in medium- and longer-term Treasury yields will likely weigh on interest-rate-sensitive sectors in coming quarters. While the ESR Group notes both the “if” and “when” of a recession are uncertain given the strength of recent economic data and decelerating inflation, their baseline forecast is for one to occur beginning in the first half of 2024.

Regardless of whether the economy enters a recession, the ESR Group forecasts home sales to remain subdued within a tight range, Fannie stated.

If the economy avoids a recession, the ESR Group expects home sales activity would continue to be suppressed by a lack of existing home inventory for sale combined with continued affordability constraints and homeowners remaining “locked in” to their low mortgage rate. Alternatively, if the economy enters a recession, improvements in affordability and inventory stemming from likely lower interest rates is expected to be offset at least in part by a weaker labor market, tighter credit, and worsened consumer confidence. Regarding new homes, both sales and construction have performed comparatively well despite higher mortgage rates to date; however, the ESR Group notes some downside risk given mortgage rates are again near 7 percent and homebuilder confidence pulled back in August.

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