Bright Economic Outlook Muted by Housing Data

Fannie Mae's Economic and Strategic Research (ESR) group is still expecting that economic growth will "likely" be solid in the third quarter, but they are otherwise hedging their bets.  In their October Outlook, the economists said the lower job growth in September does not alter their view that the labor market is strong, but GDP growth has probably slowed from its second quarter pace, partly reflecting a deceleration of product investment and consumer spending.

The surge of soybean exports that tried to get ahead of tariffs has subsided and with a strengthening dollar, the trade deficit has probably widened, and residential fixed investment is probably also down, extending that decline into a third straight quarter. Real estate sales commissions are part of that calculation and home sales have declined as interest rates have risen.

The outlook for rate hikes next year looks a trifle fuzzy.  Fannie Mae  says with the solid economic growth and inflation appearing to stay around the 2 percent level the Fed prefers, the predicted December increase seems to be on track.  However, they add that Fed Chair Jerome Powell and other members of the Federal Open Market Committee (FOMC) have repeatedly said they are shifting toward a risk management framework that seeks a balance between removing accommodation too quickly, which might end the expansion prematurely, and risking higher inflation. At present it appears that, given there is another 25 basis point increase this year, that FOMC members are evenly split among expecting two, three, or four rate hikes next year.

The ESR group however says, "If economic conditions evolve as expected, we anticipate that the FOMC will raise its short-term policy rate three more times, once more by the end of this year and then twice in 2019. Since rates on many residential construction loans are typically tied to the bank prime rate, tightening monetary policy will also likely raise builders' borrowing costs, adding to the factors inhibiting a much-needed increase in single-family housing production."

Existing home sales were flat in August after declining for the prior four months as homebuyers adjusted to higher mortgage rates and tighter inventories in many metros.  They declined again in September per the National Association of Realtor's report released after the Fannie Mae report was written.

The Outlook lays out a laundry list of somewhat negative housing indicators:

• Fannie Mae's Home Purchase Sentiment Index (HPSI) was lower in September, partly reflecting an increase in the net share of respondents expecting mortgage rates to "go up" over the next 12 months rather than down.
• The National Association of Realtors' Pending Home Sales Index declined nationwide in both July and August.
• The index of purchase mortgage applications from the Mortgage Bankers' Association fell across the entire third quarter.
• Fannie Mae's Mortgage Lender Sentiment Survey (MLSS) also reported an erosion in purchase mortgage demand in the third quarter of 2018, and lower demand may be contributing to mortgage lenders' net negative outlook as they face "competition from other lenders."

In view of these growing downside risks, Fannie Mae lowered its forecast for home sales over the remainder of 2018, and into 2019 as existing home sales are now expected to be flat next year.  They expect total home sales to rise next year as rates stabilize, but that growth will be muted.

In light of the higher rate environment and weak incoming sales and mortgage application data, the company also downgraded its projections for purchase and refinance mortgage activity.  The purchase origination forecast has been lowered by about 2 percent for both this year and next, to $1.181 trillion and $1.224 trillion respectively. The forecast for refinance volume has been revised down 3 percent to $454 billion in 2018 and by more than 8 percent in 2019, to $401 billion.

Single-family starts, a key component of real residential fixed investment, rose in both July and August; however, due to a steep decline in June, single-family construction on average across the third quarter is likely to be below its average level in the second quarter. After increasing in the years following the Great Recession, the average size of single-family homes began to decline in 2016, further suggesting that builders are producing a larger proportion of smaller homes due to the geographic spread of employment to areas with lower land costs. The cost savings from the smaller size has been offset as the price per square foot for construction rose to a new high in 2017

Multifamily starts have swung from month to month, with the 92,000 unit increase in August largely reducing the aggregate 77,000 unit decline in June and July.  Production of multifamily housing is running at an annual rate of 406,000, a robust number, and demand for multifamily rental units remains strong even though rents have slightly declined.  While they appear to have increased nationally in the third quarter by 0.75 percent to an ask of $1,267, about the same increase as a year earlier, that is about half the size of the 2018 second quarter growth.

For the economy as a whole, the ESR group says it appears to have grown faster in the third quarter than they projected last month, but their full-year growth expectations for 2018 and 2019 remain unchanged at 3.0 percent and 2.3 percent, respectively.