Housing Supply Struggles Expected to Contribute to Higher Inflation After Reopening Disruptions Fade

Our 2021 real gross domestic product (GDP) forecast was modestly revised upward to 7.1 percent from a prior 7.0 percent, on a fourth quarter-over-fourth quarter basis. This slightly faster pace was primarily due to recent data indicating stronger growth in Q2 personal consumption than we had previously forecast. However, we expect a significant deceleration in consumer spending on a quarterly basis with second half 2021 growth driven heavily by inventory restocking, while consumption shifts toward services rather than goods. We also moved the 2022 growth forecast down one-tenth to 2.7 percent and substantially revised upward our inflation forecast through our entire forecast horizon. While we believe much of the recent inflation acceleration to be transitory, price pressures are likely to last into 2022. The lagged effects stemming from recent rapid house price growth, in particular, seem poised to put upward pressure on inflation, as we describe in our recent Housing Insights piece. On an annual basis, we forecast the Consumer Price Index (CPI) will remain elevated at around 5 percent through the end of 2021 before decelerating substantially in 2022. We project the Federal Reserve’s preferred inflation measure, the core Personal Consumption Expenditure Deflator (core PCE), will end 2021 at 4.6 percent and remain elevated at 2.9 percent at the end of 2022.

We meaningfully downgraded our forecast for second and third quarter home sales, largely due to the ongoing lack of available listings and a softening pace of new construction due to supply constraints affecting homebuilders. We now expect 2021 sales to increase 4.2 percent from 2020, compared to 6.3 percent previously. For new construction, we forecast 2021 housing starts to be 17.2 percent higher than in 2020, compared to our prior forecast of a 19.3 percent gain. Even with the downgrade, this still represents the fastest construction pace since 2013. However, due to stronger recent incoming data, our overall 2021 mortgage originations forecast was little changed at $4.1 trillion; a higher expected pace of refinancing activity offset downward revisions to purchase mortgage originations. Forecast 2022 originations ticked up to $3.1 trillion from a prior $3.0 trillion.  

Long-Lasting Inflation is a Major Risk to Our Forecast
We now view stronger and persistent inflation as the principle risk to our forecast, though uncertainties over consumer behaviors related to reopening and COVID-19 developments remain. Despite a large upward revision to our inflation outlook, we did not meaningfully change our growth forecast, because we believe temporary factors are largely responsible for current strong inflation. This appears to align with the views of financial markets, which is likely keeping longer-run interest rates subdued, leading to only modest effects on growth. However, this expectation is anything but certain. We assume that the various supply chain issues that drove much of the recent inflationary jump will begin to be resolved in the coming months. If this does not occur, growth will likely be held back. Additionally, if a stronger underlying inflation trend develops, due to expectations rising or persistent labor market tightness, there is risk of a wage-price spiral. If this occurs, we believe it will likely lead to a substantial jump in longer-term interest rates and an earlier and more aggressive pace of Fed tightening. This would be expected to drag on growth and negatively impact home sales, house prices, construction, and mortgage originations. Other risks to housing include to what extent recent migration patterns to suburban areas and less expensive metros continue after full reopening, the effects on home sales and prices from the expiration of mortgage forbearance programs, and when housing construction supply chain problems are resolved.

“Transitory” Inflation Could Last Longer Than Many Expect
The CPI rose 0.6 percent in May, following a jump of 0.8 percent in April. On an annual basis, prices were up 5.0 percent, the highest rate of inflation since 2008. The initial muted financial market response, including minimal movement in the spread between Treasury rates and Treasury Inflation-Protected Securities (TIPS) suggests the market continues to view the recent jump as temporary. Ongoing supply chain disruptions led to a second month of outsized price gains in new and used autos. Together, they accounted for nearly half of the month-over-month headline gain. Large price gains in various “reopening” sectors, such as air travel and hotels, also drove much of the increase. Subtracting these components, the CPI rose by a much lesser 0.2 percent over the month. Furthermore, the annual measure was bolstered by weak year-ago comparisons when prices fell in the wake of the COVID-19 outbreak. This “base effect” peaked in May and will begin to drag on the year-over-year readings going forward. While we share the consensus view that much of this recent rise is therefore transitory, we see inflation pressures lasting longer than many forecasters are expecting for several reasons:

1. Auto-related price increases are likely not over. While the pace is decelerating, a common measure of used auto auction prices suggests that the CPI measure has at least another month or two of solid growth. Analysts also believe the industry’s chip shortage will not be fully resolved until at least 2022, so while price increases are likely to moderate, we believe a substantial decline is unlikely in the near term.  
2. Price growth in reopening industries will likely continue for some time. The CPI’s measures for hotel prices and airline fares were still down 5.5 and 12.0 percent in May relative to February 2020 prices. We expect these and other similar sectors to at least converge back to their pre-COVID trends, helping to offset much of the rolling off of base effects from last year’s price weakness.  
3. Shelter costs (rents and implied rents of owner-occupied housing), the largest inflation index component, are likely to accelerate as the past year’s rapid rise in house prices takes effect. Due to leases being typically set for a year, there is a significant time lag in the relationship between house price increases and rent growth, as measured by inflation gauges. Within the CPI, annual shelter prices decelerated over the past year from about 3.5 percent pre-COVID to about 2 percent in May, reflecting drops in rents following the COVID outbreak. However, asking rent measures have recently jumped, and we believe this will be a key driver of measured inflation well into 2022.
4. Broader inflation pressures are building and may prove to be long lasting. Average wages are rising significantly, as business surveys continue to report record levels of job openings and difficulty filling those positions. In May, the share of small businesses reporting their intention to raise prices hit the highest level since 1980, and earnings calls from many larger corporate firms reveal similar intentions. Of note in the May CPI report, prices for restaurants eclipsed their pre-COVID growth trend, suggesting that not all recent increases will subside after the catch-up period. Survey measures of consumer inflation expectations have also moved upward in recent months. If firms, consumers, and workers begin to act on higher inflationary worries, it could become self-fulfilling, and, historically, it has been difficult to dislodge entrenched inflation once set.

Rapid Economic Growth Expected to Decelerate Going Forward
In the short run, second quarter 2021 GDP growth is on track for a large annualized gain. We project 10.1 percent growth (up from our prior forecast of 9.2 percent). As the impact from the March stimulus checks waned, personal consumption declined in April but by a smaller amount than we had anticipated. While auto sales fell considerably in May, high frequency credit and debit card data suggest solid consumption growth over the month. After the second quarter, we expect the quarterly growth path to decelerate sharply as consumption has nearly recovered to the pre-COVID trend. We expect growth to therefore be driven more by firms rebuilding depleted inventory stocks. This should be aided by a shift in consumption away from goods to services as more activities fully reopen.

Our view on growth is dependent on supply chain disruptions being sufficiently resolved over the second half of this year, as well as a loosening in the labor market. A combination of COVID-related worries abating, schools and offices reopening, and expanded unemployment benefits ending are expected to result in more workers entering the labor market. We project payroll employment gains will accelerate in the coming months. However, if this fails to develop, not only will this add to inflationary pressure, but growth will likely be held back relative to our forecast.

Home Sales Cooling – But Not for Lack of Demand
Existing home sales pulled back in April by 2.7 percent to an annualized pace of 5.85 million, in line with our expectation. However, recent declines in pending home sales, which lead closings by 30 to 45 days on average, and purchase mortgage applications have been more pronounced than we previously expected. This, combined with a continued lack of new listings, led us to downwardly revise our near-term forecast. Existing home sales are now expected to approach a level in the third quarter only slightly higher than the 2019 average.

However, this slowdown is not being driven by waning demand. House prices continue to rise rapidly on an annual basis. Prices were up 13 percent in April from a year prior, according to the CoreLogic National House Price Index, the highest rate of growth since 2006. The most recent measures of average sale-to-asking price continued to move higher and the average time on the market remained at record lows. These all point to the continued lack of supply as the primary driver of the recent sales softening. The Fannie Mae National House Purchase Sentiment Index® (HPSI) showed a large increase in the share of respondents saying it was a bad time to buy a home in May. Respondents increasingly indicated high house prices and a lack of available listings as the primary reasons. We believe underlying demand is still substantial enough to drive a much higher rate of sales if the inventories were available. We are expecting at least a modest increase in listings in coming months as COVID worries wane, some homeowners reassess their living situations once the future of work-from-home arrangements becomes clearer, and mortgage forbearance programs expire. We are not expecting a high rate of foreclosure activity to follow later this year, in part due to large gains in homeowner equity this past year, but we anticipate some homes will be put on the market for sale.  

Ongoing supply constraints are dragging on homebuilders. Anecdotal reports of builders refusing new orders or delaying construction are consistent with April single-family housing starts falling 13.4 percent. However, the lack of listings available continues to drive demand for new home construction, and we expect some rebound in starts activity in coming months. This is supported by housing permits being comparatively higher than starts and lumber prices falling considerably over the past month. Homebuilders also have a large construction backlog remaining; the share of new homes sold in April but not yet started rose considerably. Additionally, using our proprietary Desktop Underwriter (DU) purchase application data, we continue to see a heightened level of buyers moving out of their current metros to less expensive and less dense metro areas. Demand in these less dense metros with greater land availability should continue to support single-family home construction. Still, ongoing labor scarcity and a lack of buildable lots is limiting production capacity and we believe homebuilders will have difficulty ramping up further. We therefore downwardly revised our near-term single-family housing starts forecast, though 2021 single-family starts are still expected to be 20.2 percent higher than in 2020.

Despite single-family starts pulling back in April, multifamily starts edged up 0.8 percent to 482,000 annualized units. While the series is notoriously volatile, the strong pace during 2021 exceeded our prior expectations. While we believe the current pace will not be sustained, rent metrics show a strong rebound over the past month as leases signed in the wake of the COVID outbreak renew and reopening continues. Rent growth has been particularly strong in many suburban and smaller metro locations. This helped support multifamily construction over the past year as a noticeable shift in construction occurred toward these geographies. We revised upward our near-term multifamily starts forecast and now expect a rise of 9.5 percent in 2021 from 2020.

For more on multifamily market conditions please see the June 2021 Multifamily Market Commentary.

Interest Rates Not Reflecting Current Inflation
After the impressive run-up of the 10-year Treasury in the first quarter of 2021, peaking at 1.74 percent in late March, the 10-year stabilized for much of the second quarter between 1.55 and 1.65 percent. In early June though, the rate trended downward and, as of this writing, sits at 1.47 percent, the lowest reading since the beginning of March. As mentioned above, the bond market appears to believe recent inflation measures are largely transitory and is likely waiting for a more concrete sign from the Fed regarding its opinion on inflation and the timing of tapering its asset purchases. While we believe the Fed is unlikely to make major changes to its policy in the coming months, the economic projections from its June 15-16 meeting will likely provide insight on these topics.

The 30-year fixed mortgage rate experienced a similar stabilization to the 10-year Treasury; after peaking at 3.18 percent in the first week of April, it declined and has trended just below 3 percent since the end of April. Mortgage spreads compressed in May, briefly falling below 130 basis points for the first time since 2011 and well below the prior decade's average of approximately 170 basis points. Our outlook for the 10-year and the 30-year fixed contract rate were unchanged at 1.6 percent and 3.0 percent, respectively, in 2021. For 2022, we expect the 10-year and the 30-year fixed contract rate to rise to 1.9 percent and 3.3 percent, respectively.

Consistent with the revisions to our housing outlook, we downgraded our expectation for 2021 purchase mortgage origination volume by $33 billion to $1.8 trillion. We expect purchase volumes to grow by 4 percent in 2022 to $1.9 trillion, essentially unchanged from last month’s forecast. We expect refinance origination volume to be $2.3 trillion in 2021, a modest upward revision of $54 billion from last month’s forecast, as incoming application activity continued to stay at a relatively high level and interest rates remain low. We forecast refinance volume in 2022 to total $1.2 trillion, up from last month’s forecast, but a decline of 49 percent from 2021. Thus, we expect refinance volume will pull back from the 2020 peak throughout our forecast horizon. At the current interest rate level, we estimate around 49 percent of all outstanding mortgages have at least a 50-basis point rate incentive to refinance, down slightly from 51 percent in last month’s forecast.

Economic & Strategic Research (ESR) Group
June 11, 2021
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, Fannie Mae ESR Analysis, RealPage, Fannie Mae Home Purchase Sentiment Index®, Federal Reserve.

Opinions, analyses, estimates, forecasts 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 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.