A “modest” recession is still coming, despite a surprisingly resilient U.S. economy, Fannie Mae’s Economic and Strategic Research (ESR) Group said Tuesday.
Even with recent data showing a surprisingly strong labor report; a Consumer Price Index (CPI) report that showed inflation falling at a slower rate than many economists thought; and, retail sales and manufacturing output much stronger than expected, the ESR Group said it still forecasts the economy to fall into a modest recession, likely in the second quarter of 2023.
Among the reasons for that forecast are “economic headwinds from unsustainably high consumer spending relative to income; significant declines in monetary aggregates; an increasingly inverted yield curve; and stickier-than-expected inflationary pressures,” the ESR Group said.
“While some of the recently reported economic strength is probably a side effect of abnormal seasonal consumption and hiring/layoff patterns overstating the true strength of the economy, these data releases were consistent with an easing in financial market conditions to start the year,” the ESR Group said. “Importantly, it raises the possibility of the Federal Reserve both pushing its federal funds rate target higher than currently expected and keeping it there for longer to meaningfully slow economic momentum and inflation, posing larger and longer-term risks to the economy and financial stability.”
Earlier this month, the Federal Reserve announced a 25-basis-point increase to the federal funds rate — the eighth and smallest increase since the Fed began raising rates last March.
The Federal Open Market Committee also unanimously approved raising the target federal funds rate range to between 4.25% and 4.75%, issuing a statement that noted the committee “anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.”
Fed Chairman Jerome Powell said the committee continues to believe “ongoing increases” in the federal funds rate are appropriate, with the target peak range for this year set at between 5% and 5.25%.
The ESR Group also noted that the housing market also started 2023 on a relatively high note, given the roughly 100-basis-point decline in mortgage rates since November. Still, the group said it expects that to likely prove temporary as well.
“Ongoing affordability constraints; the ‘lock-in’ effect creating a financial disincentive for the majority of current homeowners with mortgages to move; and still-tight inventories are expected to continue to limit home sales,” the group said.
In addition, it said, “the 10-year Treasury has increased meaningfully in recent weeks, suggesting that mortgage rates are likely to begin rising again.”
The group said it expects the volume of housing starts to decline as well, “as there remains an elevated number of new homes for sale that are already under construction or completed; these projects will likely be prioritized by builders, rather than breaking ground on new ones.”
Doug Duncan, Fannie Mae senior vice president and chief economist, said the recent stronger-than-expected data will “likely lead to tighter monetary policy with attendant increases in interest rates. While some optimism appears to have crept into the housing sector, it represents an increase from very low levels of activity and is at risk of declining again if rates reverse.”
“Right now,” Duncan added, “it’s difficult to ascertain whether COVID-induced consumer behavior changes and business practices are altering seasonal data adjustments, or if the real underlying economic activity is as strong as some recent economic indicators suggest. While we now believe the expected economic downturn will not start until the second quarter of 2023, we still think a mild recession is in the cards.”
