A recession is still in the cards for the U.S. economy, but the housing market's resilience is likely to make it not that bad, according to a recent Fannie Mae economic forecast report.

Fannie Mae continued to forecast a modest recession beginning in the fourth quarter of this year or the first quarter of 2024, but said that housing is the backbone that would support any downturn in the U.S. economy. 

Underpinning the strength of the U.S. housing market is a limited supply of homes that have exceeded prior expectations and strong buyers' demand, the mortgage giant said.

This dynamic has helped prop up prices, despite earlier predictions to the contrary. As a result, Fannie Mae revised home price growth to increase 3.9% in 2023 instead of dropping 1.2% in 2023. And in 2024, a drop of 0.7% is expected instead of an earlier forecasted 2.2% decrease.

"As we noted in our April 2022 forecast, whether there is a mild recession (our base case) or a soft landing, the supply issues in housing will provide a downside cushion for economic activity," Fannie Mae Senior Vice President and Chief Economist Doug Duncan said in a statement. "That is playing out quite close to forecast on existing homes, but new construction has been even more supportive than we expected."

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Despite the continued expectation of a recession, Fannie Mae increased its fourth-quarter gross domestic product (GDP) forecast to call for 1.1% year-over-year growth, up from 0.1%, mainly reflecting a more robust than previously anticipated first half of this year.

Inflation is also predicted to end the year at around 3.1% – it dropped 3% in June, the lowest level in more than two years, according to Fannie Mae.

However, reaching the Federal Reserve's 2% target rate might take longer, Fannie Mae said. As long as wage growth and GDP remained strong, the central bank's policy will remain tight for 2023.

"The Fed's policy tightening in an effort to quell inflation is probably close to finished, although their guidance is really more current than forward, and incoming data will be determinant," Duncan said. "The decline in headline inflation is encouraging, but year-over-year measures will work against further progress in the second half of 2023. Thus, we expect the Federal Reserve will stick to a 'higher-for-longer' policy after one or two more quarter-point increases until they conclude that the core inflation rate is sustainably at their 2-percent target."

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Mortgage rates have hovered between 6% and 7% since the start of the year and are likely to remain there as long as the Fed maintains its interest rate hikes. 

"Putting aside any temporary volatility, we expect mortgage rates to stay higher as well," Duncan said. "While spreads have come in a bit recently, they remain well above longer-term levels, and that means rates for consumers will likely stay elevated."

As far as the supply constraint, it is likely to drive new construction, according to Fannie Mae. Single-family housing starts surged 18.5% in May to a pace of 997,000 units, the highest level in a year and well above expectations. New home sales also jumped in May to 12.2%. However, it is not likely to put a damper on home prices for the rest of the year. 

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