Interest rates continue on an upward trend so far in 2013 with the 10-year U.S. Treasury yield recently growing above 2% for the first time since April 2011, Fannie Mae said in its latest economic outlook report.

The good news is the GSE remains relatively confident in the nascent housing recovery, noting that rising home prices could prompt more borrowers to enter the market, allowing the housing recovery to continue through 2013.

"[H]ousing should contribute to GDP on a growing basis and help to counteract fiscal headwinds," Fannie Mae's Economic & Strategic Research Group said.

Growing interest rates are the result of fewer perceived downside risks from fiscal policy and a markdown in the expected direction of the Federal Reserve’s open-ended third round of quantitative easing, Fannie Mae said in its economic outlook report.

"We now expect that QE3 will continue only through the end of this year, with a total of approximately $1 trillion of assets purchased, compared with our prior expectation of nearly $1.5 trillion of open-ended assets purchased through the first quarter of 2014," analysts at the government-sponsored enterprise noted.

The yield spread between the Fannie Mae 30-year current coupon and the 10-year Treasury has widened by about 20 basis points since the start of the year. Consequently, the yield on 30-year, fixed-rate mortgages is rising, with Fannie Mae project the rate to rise 4.1% by the end of 2013, roughly 30 basis points more than Fannie Mae’s previous forecast.

"Unless the Fed changes its forward guidance of interest rates tied to its forecast of the unemployment rate and inflation targets, we continue to expect no Fed funds rate hikes until the second half of 2015," the analysts noted. 

Inflation pressure continues to remain tame and has not sparked concerns from Fed, the GSE noted.

Director of Research Gregory Brown at Smith Breeden Associates cautioned that unwinding QE3 more quickly than anticipated could create a 'bad ending' for segments of the economy and certain market sectors, such as Treasuries.

"Given our recent history, we should be very mindful of the unintended consequences of our current unconventional monetary policy," Brown stated.

However, as housing takes off with positive improvements in home prices and record low mortgage rates, this could further juice housing demand. 

"So, it is certainly possible that recent price increases will bring people off the sidelines as they sense the market has bottomed," Brown said. "A price jump could be self-reinforcing if this causes others to worry about missing the bottom."

Fannie Mae similarly noted that housing will continue to be a building block for the economy.

The main driver for continued strength of home prices is rapid decline in the inventory of home available for sale. Additionally, positive home price expectations are a crucial factor for a continued housing recovery.

"The question mark surrounding potential tax increases and government spending cuts produces significant economic uncertainty," said Fannie Mae Chief Economist Doug Duncan. 

He added, "We also expect the housing recovery to broaden this year. However, the degree to which these drivers will serve to offset the headwinds from ongoing and forthcoming fiscal contraction is still to be determined."