Fannie Mae's economist cuts to the chase
What a difference half a year makes. In January, inflation stood at a reasonable 7% while interest rates for 30-year fixed-rate mortgages hovered around 3.6%.
Admittedly, home sales had started dropping the previous month, in December, and refi demand had been tumbling for quite a lot longer, but no-one seemed unduly alarmed. The Federal Reserve expected inflation to rise steadily for the remainder of the year, but rates would adjust accordingly.
Despite the economic challenges, the impression was that it could be managed; that it was containable.
Then, on February 24, Russia invaded Ukraine.
If energy and raw material prices were already rising, the conflict saw the cost of food and fuel skyrocket. Since the start of the war, inflation has jumped to 8.6% (and rising) while rates have almost doubled.
It’s safe to say no economist, however circumspect, had factored this component into their calculations.
It threw a proverbial spanner in the works.
Douglas Duncan (pictured), Fannie Mae’s senior vice president and chief economist, said as much.
“Energy and food costs have an awful lot to do with the war in Ukraine, because in both of those cases, the attempts to isolate Russia…the closing off of the export capability of Ukraine, have impacted pretty directly, and there’s not much the Fed can do about that.
“On the other hand, the public is unwilling to accept 8% to 9% inflation and so the Fed is in a spot,” he told Mortgage Professional America (MPA).
If the Fed’s goal of keeping inflation at 2% is to be achieved “any time soon”, Duncan reckoned demand would have to slow, which could result in job losses, too. The Fed’s own economic projections foresee unemployment rising from 3.5% up to 4.1% - a scenario it has previously described as a “soft landing”.
However, with calls for wage restraint, this will cause “some pain at the household level”.
Duncan added: “There’s no question it’s a tradeoff between the pain of reduction in purchasing power through inflation, versus more wage cuts in wage growth.
“The expectation is the Fed will target 3% or thereabouts by the end of this year, as opposed to the middle of next year. So, all of those things have led us to downgrade our forecast, certainly with mortgage rates at around 6%. That’s going to be hard on affordability for households and in the housing space.
“The thing that housing likes least is significant rises in mortgage rates in short time periods. And that’s exactly what we’ve had – it’s the most significant rise in a short time period since 1981, so we would expect this to be hard on the pace of sales.”
The facts bear this out. According to Redfin’s latest Homebuyer Demand Index, demand and sales posted their largest year-over-year declines in over two years during the week ending June 19.
Duncan highlighted another troubling piece of data: lower to middle income groups have now exhausted their savings, with only the highest income groups still posting strong data.
“Middle- and lower-income households have dropped out (of the market) because of high rates and affordability constraints,” he said.
“The folks that are still in the game are the higher income households that are paying for the higher end of the housing market.”
Duncan expressed concern, too, over cash-out refinances, revealing that Fannie Mae was “monitoring that closely to make sure that it doesn’t represent an increase in risk”.
Pressed to give more details, he downplayed concerns, underlining how underwriting standards had improved since the 2008 financial crash.
However, he added: “In a market where the predominance of cash-out refinancing will end up with households having a higher interest rate than they currently have, one of the things you want to be careful of is to ensure that they are not doing that under stress, which could lead to loan quality declines and also damage to the household.
“We’re continuously monitoring the tails of risk in that space looking at things like loan to value ratios, debt to income ratios and credit scores to make sure that there’s not a quality decline in that space as people tap their equity. We just want to make sure that that is not increasing risk.”
But it’s not all gloom and doom, Duncan said - there are still positives in the housing market, even if there’s a recession.
“A recession from our perspective is likely to be mild, in part because it’s still the case that in the US the available supply of the housing is not sufficient to meet the demand,” he said.
“If we do see a recession…as interest rates reset to a lower level it’ll increase affordability. So those who are employed and would like to buy a home, will see an improvement in the post-recession, affordability environment.
“There are also some indicators to suggest there’s some resilience in the economy that would carry it out of the second quarter through the third quarter, depending on how aggressive the Fed is. A lot of it really depends on the Fed.”