The housing market downturn will send home prices 5% lower and help push the economy into a recession

• US home prices will likely decline 5% year over year in the second half of 2023, Vanguard said.
• Strategists said the rate-sensitive housing sector will be an early indicator of the Fed's tightening.
• "The housing downturn is part of the reason why we view a mild US recession in 2023 as most likely."

The housing market will weaken further as home prices see a 5% decline year-over-year in the second half of 2023, according to Vanguard. 

The rate-sensitive real estate sector will weaken as the year goes on, representing an early sign of the effects that Federal Reserve rate hikes are having on the economy, strategists wrote in a recent note. 

But improved affordability will allow housing to serve as a stabilizing force on the economy as the sector rebounds in 2024 and 2025, Vanguard added, citing a structural undersupply of homes, favorable demographic trends and sentiment toward homeownership, and strong borrower fundamentals.

In the shorter term, however, the housing slump this year will likely help tip the US economy into recession.

Investments in housing construction and improvements were down roughly 20% at an annualized rate for the final three quarters of 2022, Vanguard wrote.

Since World War II, declines of greater than 10% coincided with recessions every time — except two wartime instances when defense spending propped up the economy, according to the note.

"The housing downturn is part of the reason why we view a mild U.S. recession in 2023 as most likely," Vanguard said.

Meanwhile, S&P CoreLogic Case-Shiller data showed that home prices made a surprise rebound in February, after falling for seven consecutive months before that.

And Morgan Stanley analysts wrote in a recent note that the housing market is about to bottom, and that should enable a soft landing for the economy.