Economic Developments - August 2024

Labor Market Data Caused a Growth Scare, but Continued Expansion Still Expected

Second quarter GDP came in stronger than expected at 2.8 percent annualized, pointing again to the resilience of consumer spending that should provide some momentum into Q3. However, consumers are continuing to spend at a pace in excess of disposable income growth – the savings rate dipped by another tenth in June to 3.4 percent, compared to a pre-pandemic normal of around 6-7 percent. With a projection for decelerating home prices, wealth-effect driven consumption that has likely helped suppress the savings rate should slow moving forward, and we expect income and spending growth to come into greater alignment. Consumer credit growth has recently been weak, while delinquency rates have risen, suggesting stress in some consumer segments.

With this backdrop, labor market data was sharply weaker in July as nonfarm payrolls increased by a modest 114,000 and the unemployment rate moved up two-tenths to 4.3 percent, both worse than consensus expectations. The brisk increase in the unemployment rate this year, which is now six-tenths above its January level of 3.7 percent, is particularly notable. Historically, such significant rises in unemployment in a short period of time have coincided with economic downturns. While other factors likely contributed, including weaker guidance from large tech firms and a surprise rate policy change by the Bank of Japan leading to an unwinding of carry trade positions, the release of the labor report sparked meaningful financial market volatility on the worry that the labor market was deteriorating at a faster pace than previously anticipated.

However, the recent jump in the unemployment rate to 4.3 percent was at least partially due to temporary layoffs that may have stemmed from weather events and other non-cyclical factors such as the retooling of auto plants. Additionally, much of the rise this past half year has been due to re- and new entrants into the labor force, rather than a steep rise in permanent layoffs. We see this as consistent with our broader GDP forecast that shows a significant slowdown in growth by the end of the year, but still attaining a "soft landing" as inflation continues to decelerate. We also see a slower pace of hiring and quits combined with little evidence of heightened layoffs from the Job Openings and Labor Turnover Survey (JOLTS) consistent with this view. Still, we note that the odds of a downturn have increased relative to our prior outlook.

Bond markets following the labor report were pricing in a near-guaranteed chance of a 50-basis point cut to the Fed Funds rate in September but, as of this writing, had reduced those odds to only 25 percent following less worrisome data. The July Consumer Price Index (CPI) report continued to show progress toward the Fed’s inflation target but not evidence of a sudden collapse in demand, and subdued unemployment claims suggest the labor market is not deteriorating. In line with current market views, we expect a 25-basis point cut in September. However, the August employment report, in which we are expecting the unemployment rate to pull back a tick, will likely have a meaningful impact on market expectations of future interest rates, depending on whether it shows continued weakening at the pace of the July report or not. Still, with inflation continuing to decelerate and labor markets softening to at least some extent, a period of rate cuts going forward is expected, but the magnitude and speed of such cuts is highly conditional on incoming data.

Home Sales Poised to Stay Lower for Longer

We have revised downward our existing home sales forecast despite a lower mortgage rate outlook this month. In June, existing sales fell 5.4 percent to an annualized pace of 3.89 million, weaker than we had anticipated. Furthermore, there has been little evidence in high frequency data pointing to any meaningful movement in home purchase activity in recent weeks despite the pullback in mortgage rates. Purchase mortgage applications, as measured by the Mortgage Bankers Association, have hardly budged in recent weeks, and Redfin's Homebuyer Demand Index, which tracks the number of showing requests and listing views, has not risen and remains 10 percent below activity levels from a year prior. Furthermore, the most recent reading of Fannie Mae's Home Purchase Sentiment Index® continues to point to a near-record low share of respondents indicating it is a "good time" to buy.

Active inventories of homes for sale have been rising throughout this year, but this increase has not been because of a robust rise in listings of homes added to the market. Rather, while new listings have risen modestly, the main driver is the fact that these listings have not been met with any increase in actual home sales, and therefore total inventories are rising and the average time on the market is increasing. We therefore now expect demand to remain suppressed and for a meaningful move upward in sales to be delayed until later in 2025.

We have interpreted this lack of sales growth despite rising listings to mean that there is not sufficient purchase demand at current price points and mortgage rates. Redfin’s weekly market report shows a continued rising share of listings that have experienced a weekly price drop over the prior 4-week rolling average, now at 7.0 percent as of the most recent reading, up from 6.3 percent a year prior. We are anticipating house price growth to decelerate over the next year to a pace below the growth rate in nominal incomes. Our most recent house price forecast is for house prices to grow on a Q4/Q4 basis by 6.1 percent in 2024 but then decelerate to 3.0 percent growth in 2025, as measured by the Fannie Mae Home Price Index. This compares to our Q4/Q4 projection of per capita personal income, consistent with our macroeconomic outlook, of around 4.5 percent in 2025. We are therefore expecting typical incomes to start rising faster than house price appreciation next year. Combined with a projection of a gradual downward drift in mortgage rates, and thus diminishing lock-in effects on the seller side, we expect a moderate improvement in affordability next year to eventually reach a point where additional homebuyers come off the sidelines. Of course, the magnitude and timing of this home sales recovery is highly dependent on future mortgage rate paths, which are likely to be especially sensitive to future macroeconomic data.

Regarding new home construction, we have reevaluated our views on the future relationship between new single-family home sales and single-family housing starts, resulting in a modest downward revision to our single-family starts outlook and an upward adjustment to our new home sales outlook. A significant and growing number of new homes for sale are already under construction or completed. Meanwhile earnings reports and guidance from publicly traded homebuilders show continued strong gross margins and willingness to use incentives to drive sales. Therefore, we expect a period where sales are kept comparatively strong but starts will be somewhat softer as previously started homes are used to satisfy sales demand.

It should also be noted that many of the above dynamics currently vary greatly be region. Rising for-sale active inventories are, on net, exclusively due to the South and Mountain West states, while inventories have hardly budged on average for the rest of the country. We see multiple factors driving this. The Sunbelt has had a stronger construction boom in recent years following the pandemic, so added supply is loosening up the market, which will ultimately aid affordability. The Sunbelt also had a disproportionate in-migration wave following the pandemic, and some of these movers likely represented demand being pulled forward, so we are now in the give-back period of this pull-forward in demand. And lastly, while the Sunbelt still has comparatively less expensive homes than many Northeast and West Coast metros, the relative shift in affordability has been much more severe in recent years, so the normal pool of buyers are likely more stretched. This is particularly true in some states, for example Florida, where insurance rates have also risen greatly in recent years, further constraining affordability.

Economic & Strategic Research (ESR) Group
August 15, 2024
For a snapshot of macroeconomic and housing data between the monthly forecasts, please read ESR's Economic and Housing Weekly Notes.

Data sources for charts: Bureau of Labor Statistics, Census Bureau, National Association of REALTORS®, Freddie Mac, Fannie Mae ESR

Opinions, analyses, estimates, forecasts, beliefs, and other views of Fannie Mae's Economic & Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, beliefs, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.