Economy Commentary
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Lots Of Stuff May Or May Not Happen In 2023

January 2023

As far as 2023 outlooks go, that’s about as clear and concise, not to mention precise, as we can be. Consider it the triumph of experience over hope. Really, if the experience of the past three years hasn’t been enough to dissuade one from making detailed predictions as to how the coming year will play out, nothing will. A year ago at this time we found ourselves wondering whether we’d settled into a new normal in which the only thing normal is that nothing is normal. In hindsight, thinking that 2022 would help answer that question was, well, hopeful, naïve, or just downright foolish, take your pick. Then again, that we’re still asking that question may in and of itself be the answer to that question. Either way, 2023 is likely to be quite challenging for the U.S. economy.

With the caveat that making a forecast and having a high degree of confidence in that forecast are two different things, we offer this outline of how we see the economy playing out in 2023. After what we expect will be full-year 2022 real GDP growth of 2.0 percent, our baseline forecast anticipates real GDP growth of around 1.0 percent in 2023, with even slower growth in private domestic demand – combined business and household spending. We do not have a recession as our base case, putting us at odds with many of our counterparts. The last time we found ourselves so out of step with recession calls was 2019 when, coming into that year, many thought that the age of the expansion which started in 2009 meant that it was destined to end. That was of course nonsensical, but we will concede the case for recession in 2023 is much stronger.

There is no denying that a period of significantly elevated inflation and rising interest rates has soured consumer and business sentiment. Indeed, many CEOs have been making recession calls of late, which is not a trivial point in that we believe it is possible to talk yourself into a recession. One issue firms across a wide swath of industry groups are struggling with is trying to gauge the strength of demand, both near-term and long-term. While many firms faced extraordinarily rapid growth in demand over much of 2021 and 2022, that growth was in many cases a function of two factors. One, firms rushing to fill in the gaps left by production having been disrupted by the effects of the pandemic on the labor market, supply chains, and shipping networks, and, two, firms building up inventories to levels higher than were considered normal prior to the pandemic as a hedge against further supply chain/labor supply disruptions. Much of that catch-up/precautionary demand began to wane in late-2022, leaving firms trying to right-size production plans. If firms are gearing up for a slower trend rate of demand growth, they will have less need to engage in capital spending. Indeed, leading indicators of business investment as reported in the GDP data weakened markedly in late-2022, leading us to downgrade our forecast of 2023 real GDP growth.

If enough of those with ultimate responsibility for calls on hiring and capital spending act accordingly, the effects will certainly be felt throughout the economy, particularly to the extent that consumers begin to doubt their job and income prospects and act accordingly when making spending decisions. As it is, we expect growth in consumer spending to slow considerably in 2023. Much as the rush of spending on consumer goods seen in the early phases of the pandemic has faded, we expect that will be the case with the rush of spending on services seen over the back half of 2022. Though households are still sitting on elevated buffers of savings, we expect them to try to preserve at least some of these buffers, particularly with the incentive offered by higher interest rates.

While we look for further declines in construction and sales of single family homes, we think that the housing market having been chronically undersupplied for the better part of the past decade puts a floor under demand. Indeed, applications for purchase mortgage loans were quick to respond to the dip in mortgage rates in late-2022, and we think that will also be the case as lower prices and falling mortgage rates ease affordability constraints as we move through 2023. That isn’t to say we expect a surge in home sales such as that seen in mid-2020, but instead a more gradual increase. Even if we are correct on this point, sales may come more out of current inventories of new homes under construction, which rose sharply over the latter half of 2022, as opposed to triggering significant increases in new single family housing starts.

Though there are signs it has begun to cool off, the labor market is still characterized by a glaring imbalance between labor demand and labor supply. As of November, there were over 10.4 million open jobs across the U.S. economy, down from a record of over 11.8 million in March 2022 but still roughly fifty percent above pre-pandemic levels and equivalent to 1.7 open jobs for each unemployed person. What is puzzling is that, even with the economy having slowed and at best modest expectations for 2023, job vacancies remain so high, particularly as they remain elevated across all industry groups. The manner in which labor demand and labor supply become more balanced will be a key determinant of how the economy fares in 2023. We expect falling job vacancies and reductions in hours worked to be the prime components of that rebalancing, as opposed to significant and widespread layoffs. If we’re wrong, however, and firms are more aggressive in laying off workers, the jobless rate will rise further and growth in personal income, consumer spending, and, in turn, real GDP will be lower than we now expect.

We anticipate the FOMC raising the Fed funds rate by twenty-five basis points at their January 31-February 1 meeting, with another like-sized increase possible at their March meeting. With clear, and at least to us convincing, evidence of the economy slowing, the labor market cooling, and inflation decelerating, we expect the FOMC to wind down its series of rate hikes. Winding down rate hikes, however, does not by any means suggest rate cuts are soon to follow and, with inflation lingering above their 2.0 percent target through most or all of this year, we do not expect the FOMC will cut the funds rate in 2023. There are obviously risks both ways – higher and more persistent inflation would surely lead to further rate hikes, while a more severe slowdown in the broader economy could be the catalyst for rate cuts.

As we all by now know well, stuff happens and things change, to use highly technical language, and our forecast can and will change as the year progresses. About the only thing we can be certain of is that by the end of 2023 the economy is unlikely to look as we now expect it to. What we don’t know right now is why that will be the case.

Sources: Bureau of Labor Statistics; Institute for Supply Management

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