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After two years of high nominal growth in the US — a result of supply imbalances, the Russia-Ukraine war, and demand driven by fiscal and monetary stimulus — I expect lower inflation in 2023, as well as higher unemployment. The Federal Reserve has rapidly adjusted monetary policy to bring inflation back toward its target. Supply-chain improvements and replenished inventories are also helping the cause, in conjunction with slower demand in many core goods areas. The deep housing recession should bring shelter inflation lower over the course of 2023. We could even see some moderation in other sources of service inflation, including demand, which was elevated after pandemic lockdowns were lifted, and wage growth.
Consumers are likely to benefit from decelerating inflation, which will boost real incomes. However, a rise in layoffs and the unemployment rate will temper consumption growth. Consumers still have US$1.7 trillion in excess savings relative to the pre-COVID trend. While much of it is in the hands of the highest income earners, this buffer has helped smooth consumption in the face of high inflation.
As I wrote previously, we saw a rotation toward service consumption and away from goods consumption in 2022. As we begin the new year, I expect the service economy will have moved up toward its growth trend line while the goods economy, which was well above trend, will continue adjusting lower.
Some of America’s largest companies have announced reductions in technology spending. This has long been an area of steady growth and plans were accelerated during the pandemic, but we’re now seeing companies pull back to align with the true underlying trends in demand. In addition, corporate confidence is low and the recent tightening of bank lending standards for commercial and industrial loans, as well as commercial real estate, suggests further slowing ahead.
At the same time, funding from the CHIPS Act, the infrastructure bill, and the Inflation Reduction Act could help keep some spending plans on track. The war in Ukraine has also boosted demand for US defense spending and exports in energy and food.
On the external front, it is possible that as the Fed’s tightening cycle winds down, the US dollar will reach a peak in 2023 and begin to weaken, bringing a revival in export growth. Pent-up demand overseas, especially in emerging markets coming out of COVID lockdowns, could offer another source of growth.
Collectively, this outlook portends weakness in employment growth next year. The post-COVID snapback in employment was driven by large companies hiring aggressively as the economy reopened, and the subsequent labor shortages spurred a reluctance to let workers go quickly when business conditions deteriorate. In the meantime, small companies have had tremendous difficulty finding workers, leaving job openings at an elevated level despite the softening economy. But with some large companies announcing hiring freezes and cutbacks, small companies stand to benefit.
Improving productivity could be a bright spot in 2023, with new hires hitting their stride and contributing to efficiency gains while companies prune excess labor to reflect demand conditions.
After years of easy money, the rapid rise in interest rates in 2022 deflated asset values across the equity, fixed income, digital currency, and real estate markets. It is worth noting that, relative to the 2008 financial crisis, these declines came after a prolonged period of rising prices that left many households and companies with a cushion. In aggregate, household and corporate balance sheets remain in strong shape as debt has been termed out.
That said, variable-rate consumer loans in the auto and credit card space are more vulnerable to a default cycle. Student debt is another area to watch, with interest payments set to resume no later than the second half of 2023 as COVID-driven forbearance expires. In the corporate space, leveraged loans and floating-rate debt would be areas to monitor. Pressure on commercial real estate will likely mount as well, given high office and retail space vacancy rates.
After two active years for legislation, including passage of a variety of stimulus bills, a divided government means legislative gridlock. The Biden administration will likely turn its attention to regulatory and trade policy.
On the regulatory front, areas such as energy permitting, consumer credit card charges, and crypto “guardrails” could be at the top of the list. From a trade standpoint, the Indo Pacific Economic Framework was a welcome breakthrough in 2022 and could continue to evolve next year. Its distinguishing feature is a focus not on the typical market access issues, but on finding common ground in areas of sustainability, digital transformation, and inclusion. Additional scrutiny on strategic industries that export to China is also possible, as there is bipartisan support for further decoupling between the two nations.
One potential wild card is an effort to arrive at a more cohesive energy policy in Washington. Countries in Europe would be interested in liquefied natural gas (LNG) exports from the US, as noted recently by the UK. However, infrastructure needs and a lack of clarity from the US government are holding back domestic investments in many parts of the energy supply chain. Finally, from a financial market standpoint, raising the debt ceiling in the coming year will be critical from a market risk standpoint, especially with US public debt now at 100% of GDP.
In short, the US economy is facing another year of adjustment. I expect to see inflation finally begin to decline, the economy adjust to higher interest rates, and labor markets feel the pain of restrictive Fed policy. The normalization of the nominal growth backdrop is likely to be a key feature of 2023.
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