What does this year hold in store for the economy? Banks have not very divergent answers on this question. But all the answers start from a single question: What will happen to inflation in 2023?
This is the fundamental issue, because the policy of the Federal Reserve and, in general, of central banks depends on it, and the extent of the recovery in activity depends on monetary policy.
Key issue: inflation
And we talk about recovery, because one word that appears in all the reports is recession. Goldman Sachs says that "the US should narrowly avoid recession as core PCE inflation slows from 5% now to 3% in late 2023 with a ½pp rise in the unemployment rate."
To be sure, the tightening in financial conditions is weighing heavily on growth, to the tune of nearly 2pp at present. But real disposable personal income is rebounding from the plunge seen in H1-when fiscal tightening and sharply higher inflation took their toll-to a pace of 3%+over the next year (Exhibit 4). And while there are risks on both sides, we think the real income upturn is likely to be the stronger force as we move through 2023.
And "To keep growth below potential amidst stronger real income growth, we now see the Fed hiking another 125bp to a peak of 5-5.25%."
JP Morgan
At the heart of this analysis is what happens to inflation. JP Morgan makes it very clear:
As we look to 2023 the most important question is actually quite straightforward: will inflation start to behave as economic activity slows? If so, central banks will stop raising rates, and recessions, where they occur, will likely be modest. If inflation does not start to slow, we are looking at an uglier scenario. Fortunately, we believe there are already convincing signs that inflationary pressures are moderating and will continue to do so in 2023.
JP Morgan believes that "Despite remaining above central bank targets, inflation should start to moderate as the economy slows, the labor market weakens, supply chain pressures continue to ease and Europe manages to diversify its energy supply.
HSBC
The opinion of HSBC focuses on a different aspect:
While inflation should come down in 2023, it is unlikely to get anywhere near the typical 2% central bank targets. That means that central banks are not yet done with their rate hikes, and many will want to keep their rates in restrictive territory to ensure the inflation dragon is really slain. In the case of the US Federal Reserve, we think rates will go to 5% in Q1 and then stay around that level through 2023 and 2024.
And Jim O'Donell, CEO of the Global Wealth division of IITC considers that "As inflation subsides, we see the US Federal Reserve pivoting from interest rate hikes to cuts and markets shifting focus to 2024 recovery, unlocking more potential opportunities for investors."
No rate cuts
But there will be no rate cuts in 2023, if Credit Suisse forecasts hold true:
Our key assumption is that it will remain above central bank targets in 2023 in most major developed economies, including the USA, the UK and the Eurozone. We do not forecast interest-rate cuts by any of the developed market central banks next year.
The vision of Barclays is no more optimistic: "Even if central banks stop hiking early next year, they might have to hike further later in the year. If 2022 was the year of policy "shock and awe," 2023 will be the year of living with it".
By a different route, the following concur in the same opinion BNP Paribas:
A deterioration of the labor market will be key to bringing services inflation under control. Goods inflation should drop thanks to base effects and lower demand, while shelter costs will eventually reflect the ongoing slowdown in the housing market. We anticipate core personal consumption expenditures (PCE) inflation will fall below 3% by the end of 2023.
Strengths of the United States
In fact, the U.S. economy seems to have some strengths that other economies, such as those in Europe, lack. Will the U.S. economy reach recession? "We expect any recession to be mild because the jobs market will likely remain strong. Quite simply, it's difficult to expect a deep recession with such a robust labor market," Morgan Stanley says.
BNP Paribas adds:
One open question is whether wage inflation can be reduced without a large increase in unemployment. The number of job vacancies relative to the size of the labor force is still about twice the long-run average, meaning companies are forced to raise wages to attract workers. Historically, vacancies only decline significantly when the unemployment rate rises. The US Federal Reserve believes that the currently high number of vacancies reflects the reorganisation of the labor market and the economy following the pandemic. As that process ends, vacancies could fall without the unemployment rate necessarily rising.
This is not 2008
JP Morgan cites another strength of the U.S. economy:
Thankfully, the risks of a deep, housing-led recession of the type experienced in 2008 are low. First, housing construction was relatively subdued for much of the last decade, which means we are unlikely to see a glut of oversupply driving house prices materially lower. Second, those that have recently bought at higher prices were still constrained by the banks' more stringent loan-to-value and loan-to-income ratios. Finally, the impact of higher rates on mortgage holders is likely to be less severe. In the US, households did a good job of locking in the low rates experienced a couple of years ago. Only about 5% of US mortgages are on adjustable rates today, compared with over 20% in 2007.
Europe is heading for recession
The situation in Europe and China is different. "Advanced economies are heading into a recession, led by the euro area and the UK. But the US will also likely contract across 2023, as the lagged effects of a super-fast hiking cycle finally hit the economy," according to Barclays. Credit Suisse believes that the United States can avoid recession, with implications for other economies:
We expect the Eurozone and UK to have slipped into recession, while China is in a growth recession. These economies should bottom out by mid-2023 and begin a weak, tentative recovery - a scenario that rests on the crucial assumption that the USA manages to avoid a recession.
According to Goldman Sahcs, the resilience of the U.S. economy "contrasts with a European recession and a bumpy reopening in China."
Global overview
The last important consideration comes from Credit Suisse:
The world of multilateralism and strong mutual trust between countries and governments came to an end – or at the very least paused – in 2022. Deep and persistent fractures emerged in the geopolitical world order, giving rise to a multipolar world that we believe is likely to last for years. The global West (Western developed countries and allies) has drifted away from the global East (China, Russia and allies) in terms of core strategic interests, while the global South (Brazil, Russia, India and China and most developing countries) is reorganizing to pursue its own interests.
