Is a recession on the horizon?

Kathy Bostjancic

Kathy Bostjancic

The bear market, the war in Ukraine and the imbalance of the supply chain are some of the unexpected things that will affect the US and the world economy in 2022. But what can you expect in 2023?

As the new year approaches, the National Economist Kathy Bostjancic and his team of economists closely monitor world events and key economic indicators to understand how the economy can grow. October, Bostjancic successful recently retired former economist David Berson. She is the second person and the first woman to be appointed as the country’s chief economic officer. He is regularly quoted by the national and international media, joining the entire country with local and international economic experts.

Bostjancic recently discussed the economic outlook for the next six to 12 months, the expectations of the Federal Reserve Open Market Committee, and the possibility that the US will be in recession this time next year.

Q: How would you view the economy today?
Bostjancic: The economy is still running at a strong pace as the labor market remains strong and consumers tap into pandemic-related savings to support their spending. However, the economy appears to be at the end of a business cycle where economic activity is growing strongly and benefits to labor markets and manufacturing are struggling, leading to higher inflationary pressures. The labor market remains strong as evidenced by a very low unemployment rate, 3.7% in October, and a high number of job openings per unemployed person, at about two to one. While strong labor demand is supporting faster wage growth, wage incomes are still lagging behind the pace of inflation, leading consumers to tap into their savings and rely more on debt to finance their current spending.

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Question: Why is inflation such a problem?
The persistent inflation is the result of pandemic-related factors including supply chain disruptions, a record amount of monetary stimulus and ultra-easy monetary policy that has influenced consumer and business spending. This led to aggregate demand far exceeding aggregate supply, pushing the economy into a late cycle phase. The outbreak of war in Ukraine increases supply constraints, especially food and energy, leading to another leg of inflation.

Fortunately, the easing of supply pressures and the shift away from spending on heavy goods towards more services have led to an increase in consumer goods prices. Inflation of food and energy prices eased to 5.1% in October from a recent peak of 12.3% in February. However, core services inflation, which excludes energy services, rose to a 40-year high of 6.7%. Sharp disinflation in commodity prices has allowed the annual consumer price index (CPI) to cool from the recent peak of 9.1% to 7.7%, while the core CPI has gradually decreased to 6.3% from the cycle high. 6.6% in September. Going forward, we expect inflation in the goods sector to continue, but a gradual increase in services inflation should keep overall inflation improving gradually.

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Question: The Federal Reserve Open Market Committee, led by Chairman Jerome Powell, has moved quickly to raise interest rates to reduce inflation. Do you expect inflation to rise over the next six months?
The Federal Reserve is firmly focused on reducing the rate of inflation back to the 2% target level in the medium term. Thus, policy officials are ready to drive the policy rate to 5.0-5.25% and hold it at that level of restraint in 2023. In addition, the Fed reduces its balance sheet to a cap target of 95 billion dollars per month.

Aggressive Fed tightening has hit the housing market particularly hard because it is the most interest rate-sensitive sector of the economy. With mortgage rates rising to 7%, the housing market is already in recession and the sector is a leading indicator of the wider economy.

Beyond housing, high corporate borrowing rates are hurting investor sentiment about technology stocks because they are among the most indebted sectors. Consumer lending rates on cars and credit cards have also increased, but large pent-up demand for cars amid supply pressures is supporting car sales. Currently, consumers continue to rely on pandemic-related savings to support their spending, but as employment demand cools, we expect consumers to become less interested and able to dip into savings by mid-2023.

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Q: Are we facing a recession? And if so, how hard can it be?
Looking ahead, we foresee a combination of factors pushing the economy into a moderate recession beginning in mid-2023. Rising commodity prices, rising interest rates, and a lower rate of excess savings will slow consumer spending. Corporate earnings growth will slow as profit margins tighten further and top-line profit growth slows as consumer spending cools. Businesses will then be forced to cut back on hiring and hold back on capital expenditures. Ultimately the job losses will lead to a reduction in consumer spending, leading the economy into recession in the second half of 2023.

We think it will be a moderate recession, with a peak decline of 1.6%, compared to the post-WWII average of 2% – without the Great Financial Crisis and the recession caused by covid.

Slowing the economy from the deep economy continues to be pandemic-driven savings, rising demand for consumer services and autos, healthy consumer and business balance sheets, and the possibility that inflation will cool next year, despite the Fed’s heated stance.


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