Economic Forecast Leading Into 2023: Bumps and Opportunities in the Road
Hold on tight: The dynamic conditions that marked the first three quarters of 2022 for the U.S. economy won’t smooth out any time soon. But the news isn’t all bad, and ultimately we may come off the rocky road with a robust private sector into 2023 and beyond.
Western Alliance Bank asked Dr. Christopher Thornberg, founding partner of the prominent economic research and consulting firm Beacon Economics, to provide a detailed analysis of the economy for our business clients as we look into the remainder of 2022 and into 2023. The following is a summary of that discussion.
- While parts of the U.S. economy will remain cool, consumer spending will continue to push the overall economy forward.
- Inflation may be peaking, but relief will take some time. What happens with price growth and interest rates will largely hinge on the U.S. Federal Reserve’s approach to quantitative tightening.
- The potential for a real recession increases as the Fed leans into quantitative tightening — but a modest recessionary climate in the near future could spell a stronger private sector in the long term.
- The growing federal deficit and debt levels are a significant economic wildcard. If bond buyers become overly nervous, the outlook could change radically.
Getting the Big Picture
Throughout most of 2022, the economy has experienced reductions in productivity even as it operated at capacity. Rapidly changing patterns of demand resulted in part from the nation’s emergence from the pandemic, which brought an enormous shift from demand for goods back to demand for services.
At the same time, stimuli from the federal government and the Federal Reserve in response to the pandemic drove larger shifts in the structure of demand. In 2020 and 2021, Congress approved $6.1 trillion in fiscal deficit spending, and the Fed enacted $5 trillion in quantitative easing, which increased the nation’s money supply by 35%. This expansion supercharged consumer demand and jump-started related investments such as homebuilding. Inevitably, this new demand has led to price inflation: As the saying goes, inflation is the unavoidable outcome of too much money pursuing too few goods.
By the third quarter of 2022, rapid price growth forced Fed policy to pivot sharply from loosening to tightening. Now, interest rates have been pushed by inflation on the long end and by the Fed on the short end. These changes have begun to put significant pressure on rate-sensitive sectors.
Focus on Housing
The sharp growth in new homes for sale in 2022 has caused some economists to predict a housing correction. There are some flaws in this reasoning, though: The U.S. housing market contains a massive amount of equity coupled with very low inventories of existing homes for sale. Homebuyers are in a much stronger position financially than they were 15 years ago, thanks to more stringent home-buying regulations. This market is not due for a collapse — at least not yet.
The major problem for new housing is the ultra-low mortgage rates homeowners enjoyed as of mid-2022. Anyone who sells in current conditions will have to go from a sub-3 rate to something significantly higher. As a result, the “move-up” market will continue to be all but frozen until interest rates drop again.
Consumers Will Carry the Economy Forward
Inflation will not cool down until real consumer demand does. As we entered Q4 2022, inflation remained higher than earnings growth, consumer spending was still growing in real terms, and savings rates remained at a reasonably healthy 5% of disposable income.
The upshot: For all the worry about rising interest rates, we can expect that consumers will carry the U.S. economy forward. There is still enough new wealth afoot to keep overall demand strong. Earnings increases are at record highs, while consumers have only recently begun turning to new debt to fund consumption. And most consumers are simply not that concerned with rising interest rates.
The Outlook for 2023
Looking ahead to the end of 2022 and into 2023, inflation will continue to run hot, and interest rates will continue to rise. These trends won’t necessarily cause a recession. Slow overall economic growth is more likely, with weaker numbers from the more rate-sensitive sectors.
The inflation forecast into 2023 depends to a large extent on the Fed’s actions. Without the right level of quantitative tightening, inflation will continue eating into real asset values and incomes, generally pushing interest rates up. In that state, any small shock could cause a recession or lead to a few years of very weak growth.
The Fed could do much to stamp out inflation in the near term by aggressively reducing its balance sheet. This would drive up interest rates in the short term, cool financial markets and possibly create a modest recession in 2022 — but the nation would emerge with a strong private sector.
One factor that has not been dealt with is the nation’s huge federal debt and the rising burden of carrying it. At some point, we can expect that bond buyers will become worried, and tough choices about fiscal rebalancing will need to be made.