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Summary
The pandemic and the associated macroeconomic policy response imparted some outsized imbalances to many economies. How households, businesses and policymakers respond to the trade-offs that they face will collectively determine economic performance in 2023.
Surging demand in conjunction with constrained supply has caused inflation in the United States to shoot up to its highest rate in decades. The Federal Reserve now faces an unpleasant dilemma: the FOMC needs to raise rates further to ensure that inflation recedes back toward target, but excessive tightening could lead to recession. We believe the FOMC will err on the side of bringing down inflation at the expense of a U.S. economic downturn in 2023.
Inflation has eroded real personal income in the United States. Yet American households have been able to maintain solid growth in spending by bringing down saving rates and incurring more credit card debt. Admittedly, these trends could potentially continue in 2023, but we look for consumer spending to begin a period of retrenchment.
Some households must decide whether to buy a house, which has become less affordable due to surging mortgage rates and the skyrocketing of home prices since the pandemic began, or to rent, the cost of which has also shot up significantly. Their decisions regarding where to live will help to determine the economic outlook in many regions of the country.
Businesses have struggled over the past few years to find qualified workers, and they are understandably reluctant to displace them. But we look for many firms to eventually reduce capex and cut payrolls to protect margins squeezed by elevated labor costs and flagging demand.
Central banks in many foreign economies face the same dilemma as the Federal Reserve. That is, they too need to bring down inflation from multi-decade highs, but excessive tightening could lead to recession. Like their counterparts at the Fed, we look for foreign central bankers to choose inflation reduction. Consequently, we forecast that many foreign economies will be in recession in 2023.
The U.S. dollar has strengthened vis-á-vis most foreign currencies in 2022, and we look for this trend to continue early next year. But as market participants begin to anticipate eventual policy easing in the United States, we believe the greenback will start to trend lower beginning in mid-2023.
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