HousingWire's Logan Mohtashami on Raising 5th Recessionary Red Flag and Recent Fed Rate Hike

Subscribe via LinkedIn Listen to this newsletter

Dwindling builder confidence, savagely unhealthy home price growth, and aggressive Fed moves to combat inflation point to impending U.S. recession, but just how close are we?

Despite having just raised the fifth of six red flags in his progressive recessionary model, HousingWire Lead Analyst Logan Mohtashami has some good news: the U.S. economy is not in recession.

According to Mohtashami, the U.S. economy has never entered a recession when incomes are rising, jobs are being added to the economy, real sales are positive, and key homeowner demographics appear strong on paper—all of which continue to be the case at the time of publication.

And while that’s good news for servicers, it also points to opportunities for originators, including lingering refinance activity and plenty of home equity plays for lenders and loan officers struggling to sustain production off the peaks of 2020 and 2021.

Mohtashami says the U.S. economy is not in a recession, but that we’re firmly in the latter stages of an expansionary period

But let’s first circle back to where exactly Mohtashami places the current U.S. economy in terms of historical market cycles. While not technically in a recession, Mohtashami does note that economic data lines are weakening (despite incomes, jobs, real sales, and industrial production boasting positive growth over the first two quarters of 2022), which signals that the U.S. economy is in the latter stages of an expansionary cycle.

Contrary to what you’ve likely heard across media outlets, Mohtashami argues that a recession is not the result of two consecutive quarters of negative GDP growth, but rather two consecutive quarters of net decline when factoring across all economic activity—an important distinction as the Bureau of Economic Analysis has already reported negative GDP growth in Q1 of this year, but has yet to report whether GDP growth was positive or negative for Q2, which could lead many to believe that we are currently entering a recession.

Technically, recession isn’t two quarters of negative GDP. It’s really kind of two quarters of economic decline in total activity. And I think people are confused about that because they saw the negative GDP in the first quarter and the second quarter is a toss-up if we’re positive 3% or down slightly. So, we’re not technically or legally in a recession currently.

— Logan Mohtashami

While he firmly believes we’re not technically in a recession, Mohtashami has raised five out of six red flags in his progressive recessionary model. So, what were the first four recessionary red flags Mohtashami has already raised? What just caused him to raise a fifth recessionary red flag? And, what would still need to happen for Mohtashami to raise the sixth and final recessionary red flag, officially placing the U.S. economy on “recession watch,” per his model?

Mohtashami explains his Six Recession Red Flag Model and just how close we are to a recession in the United States

Unlike many others who simply look to GDP, Mohtashami has developed a progressive model for predicting possible recessions that factors in what he believes to be the six necessary economic events to precipitate the conditions for a recession.

The first of those events is the unemployment rate surpassing a conditional threshold, which for Mohtashami happened well over 18 months ago.

The second event is the Fed beginning a rate hike program, which it did in March of this year.

The third event is the yield curve inverting, which it has multiple times already this year.

The fourth event—which is more subjective than the first three events—is, Mohtashami states, when there is measurable overinvestment or an unsustainable rise in demand in a specific sector. While there are arguable several examples, Mohtashami points to the demand boom in home fitness equipment and programming, the resulting overinvestment in the sector, and the recent collapse of that demand. As a poignant example, Mohtashami recounted the rise and swift fall of Peleton’s sales, stock value, and manufacturing footprint.

The fifth event, which Mohtashami argues is happening at the time of this publication, is a measurable decline in housing starts and new home sales—as predicted by forced bidding peeling off in recent weeks and dwindling builder confidence.

Editor's Note

As noted below, a report of positive new home sales for May was released after this conversation was recorded, adding nuance to Mohtashami’s concern that a slide in housing starts and new home sales is underway.

And so while that raises five of six recessionary red flags per Mohtashami’s model, to full enter recession watch, Mohtashami claims he would have to see the leading economic index (which is a set of 10 data lines) move down 4-6 months, as compared to the 1-2 months it is already down.

But again, to reiterate Mohtashami, raising a 6th recessionary red flag per his model does not mean the U.S. economy has technically slid into a recession, rather that the conditions for a recession are prime.

Mohtashami breaks down savagely unhealthy home price growth and the impact of dwindling builder confidence on depleted housing inventory

Mohtashami’s deep concerns regarding what he describes as “savagely unhealthy home price growth” can be read in detail on his appropriately title piece, The Housing Market Is Now Savagely Unhealthy (HousingWire). But in summary, sustained home price growth MoM despite the fastest running consumer price increases in 40 years, the largest single rate hike in 28 years, and home supply levels below that of the 2000 recession defies logic and points to a flagrantly imbalanced housing market.

Which begs the question, what would help rebalance the market and bring supply back in alignment with demand? An obvious answer would be restoring housing supply to healthy levels, which—according to the NAR—is about 4.3 months of supply, up from the roughly 1.2 months currently available; but, as Logan Mohtashami points out:

Builders only build off of their demand curve….they only care about selling new homes….When people say the builders didn’t build enough, that’s actually not true if you look at them as their business model. They just build slow and steady and they just try to make as much money as they can. The existing home sales market is actually their competition.

— Logan Mohtashami

According to Mohtashami, builders are benchmarking starts against demand in their local market, which, based on worsening builder confidence, appears to be slowing.

Editor's Note

After this conversation was recorded, the Bureau of Labor and HUD announced a 10.7% increase in new home sales for the month of May, a highly unexpected announcement that adds context to the waning builder confidence index Mohtashami referenced throughout this conversation. But even with the positive increase for May, new home sales continue to remain historically low.

When asked about completions, Mohtashami noted that while still lagging behind starts and permits at the moment, completions are set to overtake both permits and starts as builder confidence remains low, permitting timelines continue to lengthen, and builders focus on finishing incomplete, but permitted or started, builds:.

Completions are picking up, because they lag—which is a weird phenomenon. Housing starts and permits are actually going to go below completions soon, just because we’re just finishing up all these homes that were in the process. So that part will catch up, but the permits are slowing down and the starts are slowing down.

— Logan Mohtashami

What Mohtashami believes will be the actual impact on mortgage if the U.S. economy technically enters a recession

According to Mohtashami, the impact of a U.S. recession on mortgage servicing and origination might not be as severe as one would think, especially given the historic impact the Great Recession had on the industry in 2008—which continues to loom large in the minds of both mortgage professionals, consumers, and investors.

Mohtashami argues that rising incomes, historic levels of home equity, and an in-demand job market (currently 11.5M estimated available jobs) should protect the average homeowner if the U.S. economy were to enter a recession. Mohtashami believes the impact will be felt much more by renters (who, historically, are more susceptible to loss of employment, negative wage growth, and the effects of inflation that college-graduated homeowners), landlords, and real estate investors—though the weight of the impact is debatable.

Similarly, unlike in 2008 when the average consumer was impacted by a credit leverage bubble, Mohtashami believes that if there even is a credit leverage bubble, it’s much smaller and will mostly affect investors, many of whom should be able to weather any corresponding losses without inflicting more severe damage on the broader economy.

Where Mohtashami sees rates and home prices headed through the end of this year into 2023

According to Mohtashami, the risks for servicers in a recession are substantially lower than in 2008; but, what about the impact on originators? With the recent rise in rates, Mohtashami points to historical data about late-cycle buyers who often have the opportunity to refinance in recessionary periods, when rates typically fall as much as two (2) percentage points from their pre-recession heights.

Given the Fed’s pre-recession target rate of 1.5-1.75, Mohtashami notes that historical data around rate decreases in recessionary periods has to be considered carefully when forecasting a potential rate decrease should the Fed stem the rise of consumer prices, or the economy officially enter a recession. But, Mohtashami does believe the possible of seeing mortgage rates in the mid to high 4%’s within the next 3-4 quarters is feasible given the Fed’s aggressive response to rising inflation.

While it’s not all doom and gloom even just looking at the data, Mohtashami continues to have concerns that low builder confidence and stable buyer demand will continue to “eat-up” whatever additional housing supply is added through new home starts and demographic shifts, driving the continuation of deeply unhealthy home price growth.

That said, Mohtashami noted it’s possible that housing supply could return to somewhat normal levels as soon as 2023.