Fannie Mae Predicts Stimulus Likely To Push Up Inflation, Interest Rates

Additional federal stimulus will likely add to already-simmering inflationary pressures and may lead to a sharper rise in interest rates, according to a new Fannie Mae report released this week. 

Updated assumptions forecast a roughly $1.7 trillion stimulus package being passed by the middle of March, causing Fannie to update its full-year forecast for real GDP growth to 6.7% (up from 5.3%). If these predictions ring true, annual growth would clock in at its fastest rate in nearly 40 years. (Fannie Mae’s forecast for full-year 2022 growth was revised down to 2.8% from 3.6%, which still leaves its end-of-year projection for 2022 GDP 0.8 percentage points higher than previously forecast.)

This new expected round of stimulus would bring the total COVID-related fiscal policy response to about $5 trillion, or 23% of pre-COVID annual GDP. Typically, stimulus is targeted at some amount smaller than the expected remaining size of recovery, but the total stimulus earmarked for COVID recovery represents “a deficit expansion only rivaled by the World War II period,” according to Fannie Mae. The total is also multiple times larger than the “productive slack” in the US economy. 

The ongoing COVID-19 vaccination rollout has led to the loosening of state-level lockdown restrictions in a litany of states, and consumer spending is likely to continue on a more resilient and stable trajectory. The level of private savings is also at a high of around $1.5 trillion, and Fannie predicts the impact of COVID on consumer spending will continue to wane throughout the year. Because of that, stronger inflationary pressure is likely to build over time as output levels rise above a sustainable growth path.

Fannie’s key takeaway: the risks are larger if recovery is fast and furious. If interest rates push up quickly, it’s likely growth will slow later this year and into 2022, which would in turn lead to asset repricing. This could also be a “significant drag” on home sales and mortgage originations.

These themes have been the topic of intense discussions among politicians and economists of late. The Biden Administration has made passing a robust stimulus package a key pillar of the President’s first 100 days in office, with key administration officials maintaining that too little stimulus is more dangerous than the potential for inflation. Treasury Secretary Janet Yellen also defended the size of—and need for—the package in an interview with CNBC last week. 

“We are digging out of a deep hole,” Yellen told CNBC. “We think it’s very important to have a big package that addresses the pain this has caused.”

At the Federal Open Market Committee on January 26, Fed Chairman Jerome Powell said he expects to see some inflation this year, but would welcome the push toward the Fed’s long-run average inflation target of 2.0%.