MNI INTERVIEW: Housing Inflation To Keep Fed Cautious-Fannie

U.S. inflation could stumble at higher levels given a strong economy, booming services and persistent housing inflation, making it harder for the Federal Reserve to cut interest rates, Fannie Mae chief economist Doug Ducan told MNI.

Duncan thinks the Fed will cut interest rates gradually – certainly more slowly than in past cycles – starting in June, delivering three cuts by year-end.

“To get the rest of the way to 2% is going to be difficult. We just don’t think that’s an easy thing to do,” Duncan said in an interview. “That’s why we’re in the higher for longer camp. There are two parts to that – where they keep the level of rates and how far and how fast they lower them. We think they will lower rates less fast and less far.”

Duncan believes 30-year mortgage rates could end the year just below 6%, down from the current 6.6%. In addition, he thinks MBS spreads will narrow as rates move lower, having widened sharply to levels well above their historically average.

“Our expectation now is that total home sales in 2024 will rise about 4% from a very low level. It’s a very gradual recovery,” Duncan said.

HOUSING CONTRIBUTION

A key reason for the persistence of inflation are still-rapidly rising shelter costs, which have defied predictions for a reversal that policymakers continue to predict lies ahead.

“The CPI number came out a lot stronger than people had thought and a big chunk of that increase was housing. Shelter costs jumped 0.6% in January and accounted for more than two-thirds of the rise in monthly headline inflation, the Labor Department said Tuesday. (MNI: US Shelter Inflation Cooldown Seen Limited In 2024)

Duncan said there’s a tug of war between multifamily rents, which declined 1% in the fourth quarter and which he expects to continue cooling in the first half of this year, and new rentals, which are actually up about 3%.

“The other piece of it comes from the imputed rental cost of owned housing – and that part of it, house prices are still rising, just not as fast,” Duncan said. “I’m a bit skeptical that we would suddenly just because interest rates tightened get the supply and demand imbalance fixed. There’s no sign of that so I think it’s going to be a while."

MILD RECOVERY

Duncan says he has shifted his outlook in recent months from seeing a mild recession this year to forecasting a mild recovery, in part because consumer spending has been more resilient than expected but also because private employment is having a resurgence.

After five months where job growth was dominated by expansions in government and healthcare employment, private sector jobs are picking up again in the last three months. “That told me there was a turn that took place,” he said.

One reason economists have underestimated the strength of consumer spending is because they had benchmarked savings rates against pre-pandemic norms that appear to have shifted as higher rates mean households can get a greater return on their savings, Duncan said.

That’s helping to maintain the strength of services spending that has Fed officials focused on measures of core services ex-housing, which picked up again in the latest CPI report.

“At one point, consumers were earning less than 1% interest, so to achieve their saving goals they had to save much more principal. When interest rates came up and they’re now earning 5% they cut back on total level of savings but maintain consumption,” he said.