Economic Developments – February 2018

© 2018 Fannie Mae. Trademarks of Fannie Mae. 2.12.2018 1 of 5

Strong Economic Activity Triggers Overheating Concerns

Economic activity gathered momentum at the end of 2017 and start of 2018. Over the past several weeks, the markets 

started to appreciate the broader implications of the stronger growth path and related change in the direction of monetary 

policy, including the reintroduction of volatility in a rising rate environment.

Early signs of wage acceleration fueled concerns about rising 

inflation, pushing market-based measures of inflation expectations

such as the 10-year breakeven rate higher. Long-term interest 

rates jumped, with the 10-year Treasury yield surging to the 

highest level in four years. As of this writing, the yield on 30-year 

fixed-rate mortgages had increased for five consecutive weeks, 

reaching the highest reading since the end of 2016. 

The change in the profile of long-term rate expectations triggered 

a spike in market volatility. Following a sustained period of calm

that lured investors into short-volatility trades, the VIX Index, a 

measure of the stock market’s expectation of volatility, soared to 

reach the highest level since the aftermath of the unexpected 

devaluation of the yuan in 2015. These developments led to a 

repricing of equities, sending the stock market into correction 

territory.

Our forecast for 2018 economic growth remains at 2.7 percent. Sustained declines in the stock market and contagions to 

other markets present downside risks to our forecast, but we also see some upside risk to growth stemming from fiscal 

policy, which added additional stimulus to the economy on top of the 2017 Tax Cuts and Jobs Act. Following an overnight 

government shutdown, Congress passed the Bipartisan Budget Act of 2018 that will raise discretionary spending by 

nearly $300 billion over the next two years and extend the debt ceiling until March 1, 2019. Combined with the Tax Act, 

the Budget Act will likely worsen the deficit outlook, implying a rising supply of Treasuries and higher yields. 

 

While we expect lower tax rates to induce increased investment and labor supply, the addition of deficit-financed stimulus

at a time when the economy is already near full employment is likely to stoke more concerns over rising inflationary 

pressure and could require more aggressive monetary actions to offset the fiscal stimulus. Thus, Fiscal Policy and the 

Fed: Stimulus/Response—our theme for 2018—underpins the health of the economic expansion.

Domestic Demand Shows Solid Momentum

Fourth quarter real gross domestic product (GDP) growth slowed six-tenths from the third quarter to 2.6 percent 

annualized, as trade and inventories dragged on growth. However, the weakening headline growth masked a marked 

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'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 U.S. 10-Year Breakeven Rate

Long-Term Inflation Expectations Begin to Rise

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Long-Term Interest Rates Rise to Multi-Year Highs

10-Year Treasury Note Yield

30-Year Fixed Mortgage Rate

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Chicago Board Options Exchange Volatility Index

Stock Market Volatility Spikes
© 2018 Fannie Mae. Trademarks of Fannie Mae. 2.12.2018 2 of 5

increase in domestic demand. Final sales to domestic purchasers (GDP minus trade and inventories), which is a gauge of 

strength in domestic demand, grew 4.3 percent annualized, the fastest pace in more than three years.

 

Real consumer spending grew 3.8 percent annualized, the biggest increase since the second quarter of 2016, and added 

2.6 percentage points to growth, a contribution more than 1 percentage point greater than in the third quarter. Outlays on 

durable goods drove the gain, reflecting the surge in auto sales to replace hurricane-damaged vehicles. Residential 

investment rose the most since early 2016 and added to growth for the 

first time in three quarters. Nonresidential investment and government 

spending also contributed more to growth than in the prior quarter. 

Notably, business investment in equipment showed back-to-back 

double-digit gains, registering the strongest increase in more than 

three years. For all of 2017, the economy grew 2.5 percent, the 

best performance since 2014. 

Economic fundamentals remained solid in January. Surveys of 

purchasing managers indicate strong expansion in both the 

manufacturing and service sectors. The Institute for Supply 

Management (ISM) Manufacturing Index edged down but stayed just 

shy of September’s 13-year high, while the ISM Nonmanufacturing 

Index jumped to the highest level since August 2005.

The labor market also started the year strong. January’s job gain of 

200,000 was nearly 20,000 more than the average monthly gain in

2017. For financial markets, the game changer from the report was 

the acceleration in annual wage gains to 2.9 percent, the strongest 

pace since June 2009, which resulted in a “tantrum” in Treasury 

yields. The household survey was uneventful as the unemployment 

and the labor force participation rates were flat for the fourth 

consecutive month at 4.1 percent and 62.7 percent, respectively.

The broadest measure of labor underutilization (the U-6 rate), 

which includes discouraged workers as well as part-time workers 

who prefer full-time jobs, ticked up one-tenth to 8.2 percent. We 

remain convinced that slack remains in the labor market and expect

that hours worked will increase and more people will enter the labor 

force as wage gains firm amid rising demand for labor.

Signs of a pickup in wage growth were also present outside of the jobs report. The Employment Cost Index, which is a 

measure of labor compensation that also includes bonuses and benefits, increased during the fourth quarter at the fastest 

annual pace of the expansion, thanks to the biggest annual wage gain in nine years. Despite signs of faster wage growth, 

we expect that inflation will remain well-anchored. The passage of the Tax Act should help spur faster capital 

expenditures and productivity growth, keeping unit labor cost contained.

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Domestic Demand Surges To Its Highest Level in Three Years

Final Sales to Domestic Purchasers

Gross Domestic Product

Note: Final sales to domestic purchasers is gross domestic product less net exports and change in private inventories

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Government Consumption and

Investment

Net Exports of Goods and Services

Change in Private Inventories

Residential Fixed Investment

Nonresidential Fixed Investment

Personal Consumption Expenditures

GDP

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Exports and Inventories Drag on Economic Growth

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'07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Average Hourly Earnings (SA, Year-over-Year % Change)

Annual Wage Growth Jumps to the Fastest Pace Since June 2009

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Manufacturing and Service Activities Expand at a Fast Clip

Manufacturing

Nonmanufacturing
© 2018 Fannie Mae. Trademarks of Fannie Mae. 2.12.2018 3 of 5

 

We expect real GDP to grow 2.7 percent annualized this quarter, little changed from the prior forecast. Consumers will 

likely notice increases in their disposable income as their tax withholdings decline. However, we expect real consumer 

spending growth to moderate from last quarter’s unsustainable pace. Auto sales have been trending down after the surge 

last September, retreating in January for the third time in four months. After contributing 0.4 percentage points to GDP 

growth in the fourth quarter, the most in six years, motor vehicles and parts should drag on growth going forward. We also 

expect the increases in residential investment and business equipment spending to moderate from the double-digit gains 

last quarter. However, inventory investment should strengthen from an anemic pace, helping offset slowing domestic 

demand growth amid a continued drag from trade.

The Market Continues to Fully Price in A March Rate Hike

In the statement following the January Federal Open Market Committee meeting, the Committee noted that inflation 

remains below the 2.0 target, but also remarked that market-based measures of inflation expectations have risen recently. 

The annual increase in the personal consumption expenditures (PCE) deflator, the Fed’s preferred measure of inflation, 

decelerated slightly in December to 1.7 percent. We expect the PCE deflator to remain below the Fed target this year. 

Barring protracted deterioration in financial conditions, the Fed is expected to raise the fed funds rate in March, a move 

fully priced in by the fed funds futures market, and we expect two more hikes this year in June and December. The 

consensus view is that the new Fed Chair Powell will largely represent policy continuity of a gradual monetary policy 

normalization.

Mortgage interest rates are likely to feel the impact of three factors over the course of the year, all of which ultimately point 

in the direction of higher rates and wider spreads. First, as the Fed MBS portfolio runs off, we expect to see marginal 

investors picking up the volume requiring higher yields after mid-year. Second, the higher rate environment is intensifying 

industry competition and reducing profit margins, as noted in our Mortgage Lender Sentiment Survey. This competition 

may temporarily compress spreads resulting in industry downsizing that reduces capacity and ultimately results in wider 

spreads that restore profit margins for survivors. Third, just as Fed portfolio purchases enabled a market adjustment to a 

higher guaranty fee structure that more accurately reflected market risks, we believe the Fed departure will leave this 

structure in place in the higher interest rate environment.

This expected higher mortgage rate environment, if sustained, implies a significant reduction in refinance volume, as is 

already being made evident via competitive pressures. This is the refi story. The impact on the home purchase market will 

depend on the pace of rate adjustment. Recalling the evidence from the “Taper Tantrum” of 2013, the home purchase 

market does not respond well to large, rapid moves in mortgage rates. However, if rates move up in reasonable alignment 

with household income growth, the home purchase market can do well in a rising rate environment.

Housing Roundup

Homebuilding activity was mixed at the end of 2017 as single-family housing starts posted the worst monthly drop in 

almost three years, while multifamily starts rose for the third time in four months. However, for all of 2017, single-family 

starts rose to the highest level since 2007, while multifamily starts fell for the second consecutive year. Both new and 

existing home sales decreased in December, but annual average sales posted the best performances since 2007 and 

2006, respectively.

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ECI: Percent Change Year-Over-Year (SA, Dec-05=100)

Growth in Workers' Salaries and Benefits Picks Up

ECI: Wages & Salaries of Civilian Workers

ECI: Benefits of Civilian Workers

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Total Light Vehicle Retail Sales [Imported+Domestic] (SAAR, Mil. Units)

Auto Sales Have Trended Down from the Hurricane-Induced Surge
© 2018 Fannie Mae. Trademarks of Fannie Mae. 2.12.2018 4 of 5

 

For 2017, total home sales rose by less than 2 percent despite mortgage rates that averaged just 4 percent and the 

strongest economy in three years. The principal factor restraining home sales last year was the lack of supply. The yearover-year decline in the for-sale inventory of existing homes, which accounted for 90 percent of total home sales in 2017,

continued unabated. Given the most recent trends, supply appears unlikely to expand sufficiently to make a difference in 

sales this year. The number of existing homes for sale registered a double-digit annual percentage drop in December, 

sending the months’ supply to 3.2 months, the lowest reading since the inception of the series in 1999. There could be 

some relief for homebuilding activity. The cut in the corporate tax rate from 35 percent to 21 percent will benefit 

homebuilders, especially large ones who already own developable lots and can respond to increased demand quickly. 

The increased profit margins could spur construction of mid-priced 

and low-priced homes, whose supply has been limited. However, 

the shortages of labor and land and rising material prices will limit 

how fast builders can increase supply. Over the past several 

years, tight inventories have helped boost home price 

appreciation well past income gains, creating home purchase

affordability challenges. Unfortunately, we do not expect much 

relief on the home price front this year.

Because long-term interest rates rose more than we expected at 

the start of 2018, we revised our interest rate forecast upward. We 

now expect the yield on 30-year fixed-rate mortgages to average 

4.4 percent during the fourth quarter of this year, 30 basis points 

higher than the prior forecast. Despite the higher rate projection, 

our forecasts for homebuilding activity and home sales are little 

changed from the prior forecast. The Tax Act will provide a boost 

to disposable household income, which should counteract the 

declining affordability from rising mortgage rates. The Act also 

removes some of the tax subsidy of homeownership, especially 

for high-priced homes, and will likely hurt price appreciation at the 

upper end of the market. However, the Act’s overall impact should 

be positive for demand for moderately priced homes, despite the 

doubling of the standard deduction that reduces the tax incentive 

to buy.

Demographics is one positive for the owner-occupied housing 

market. As the millennials age amid a growing economy, they 

have accelerated their homeownership attainment, helping to 

boost the overall homeownership rate. The fourth quarter Housing 

Vacancy Survey supported our view that the national 

homeownership rate finally stabilized last year following sustained 

declines that started prior to the recession. For 2017, the average homeownership rate rose 0.5 percentage points to 63.9 

percent, driven by the biggest gain in the homeownership rate for those under 35 years old since 2004.

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New Home Sales Rise to a Fresh Expansion High

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Annual Existing Home Sales (Millions)

Existing Home Sales Post Best Performance Since 2006

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'80 '85 '90 '95 '00 '05 '10 '15 Homeownership Rate (NSA, %)

The Homeownership Rate Has Stabilized After a Downturn that Started Before the Recession

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Annual Change in Homeownership Rates: United States (NSA)

Annual Homeownership Rate Posts First Rise 

in 13 Years, Driven by Young Adults

Homeownership Rate

Homeownership Rate: Under 35 Years
© 2018 Fannie Mae. Trademarks of Fannie Mae. 2.12.2018 5 of 5

For all of 2018, we expect single-family starts to rise 8.6 percent, similar to the increase in 2017, amid a modest drop in 

multifamily starts. Total home sales should increase about 3 percent in 2018 with roughly the same pace of home price 

appreciation as in 2017. We project that purchase mortgage originations will rise about 5 percent to $1.19 trillion in 2018, 

little changed from the January forecast. However, with a higher interest rate forecast, our refinance originations

projection was revised lower by about 7 percent from the level in the January forecast to $498 billion—a drop of 29 

percent in 2018 from the 2017 level—compared with a 22 percent decline in the prior forecast. The refinance share should 

decline 8 percentage points to 30 percent in 2018.

For information on multifamily market conditions, read the February 2018 Multifamily Market Commentary.

 

Economic & Strategic Research (ESR) Group

February 12, 2018

For a snapshot of macroeconomic and housing data between the monthly forecasts, please read ESR’s Economic and 

Housing Weekly Notes

Data source for charts: Bloomberg, Federal Reserve Board, Freddie Mac, Chicago Board Options Exchange, Bureau of Economic Analysis, Institute 

for Supply Management, Bureau of Labor Statistics, AutoData, Census Bureau, and National Association of REALTORS®

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.

ESR Macroeconomic Forecast Team

Doug Duncan, SVP and Chief Economist Mark Palim, VP and Deputy Chief Economist

Orawin T. Velz, Director Frank Shaw, Economist 

Hamilton Fout, Director Rebecca Meeker, Business Analyst