The year ahead will be a test of whether inflation can fall without a rise in unemployment.
Among the economies we track, the outlook for the U.S. is the closest call. The nation endured a technical recession in the first half of 2022, using the informal definition of two consecutive declines in gross domestic product (GDP). But it certainly didn't feel like a recession: over that same interval, retail sales grew each month and over 2.6 million jobs were created.
We came into the year 2022 expecting U.S. growth to stabilize after the wild swings of COVID lockdowns and reopening. Instead, high inflation reduced real incomes and output, and higher interest rates caused a housing recession. Fortunately, strong employment conditions supported consumer spending.
Among U.S. audiences, we have frequently observed a disconnect between data and sentiment. Expert and casual observers alike would opine that the nation is struggling. But the behaviors of consumers and employers belie these feelings: we would not expect to see strong hiring and real consumption in a bad economy.
"Among U.S. audiences, we have frequently observed a disconnect between data and sentiment."
In the year ahead, we see ample reason for inflation to cool from the elevated rates observed in 2022. Real-time indicators of prices for apartment rentals and used vehicles are declining. The cost of international shipping increased tenfold at the height of supply chain dislocations but has now normalized, which will reduce inflation for imported goods.
But it is important to note that slower inflation does not mean a retreat. Many prices will settle at their current levels and hold there, leaving a feeling that things are still expensive; this can influence inflation expectations. And we should note that inflation is likely to persist above the Fed's 2% target; as reshoring takes the place of globalization and food and energy markets remain fragile, the days of persistently low inflation may not return anytime soon.
U.S. workers have fared incredibly well during the COVID recovery cycle. Unemployment is low, job openings are ample, and wage gains are strong. A cooler economy is likely to bring slower hiring and likely some job losses, especially in sectors coming off a reopening boom. Part of the reason for low unemployment is a stall in the recovery of the workforce; from family obligations to persistent illness, personal circumstances are keeping too many potential workers on the sidelines. A restoration of work-eligible immigration flows will also help to restore equilibrium.
In response to strong employment and high inflation, the Federal Reserve has raised its benchmark rate from the zero lower bound to over 4%. The Fed also pivoted from buying bonds to running down its balance sheet. In the year ahead, however, we expect a much less active Fed.
Monetary policy works with long and variable lags, and markets are still digesting significant tightening. We expect that the Fed will remain steadfast in their inflation-fighting commitment and seek to avoid a policy mistake of cutting too soon. But the potential for an overcorrection is present.
With so many challenges, setting a growth forecast for the U.S. is a major challenge. On balance, we see a year of weak growth. In a normal year, we would expect the U.S. economy to grow around 2% after adjusting for inflation; our call of less than 1% growth may technically not be a recession, but it will feel like one. Should a recession materialize, the strength of balance sheets across the economy should help limit its depth and length.
Absent something sudden that pushes the economy into contraction, we believe the U.S. economy should muddle through, but risks are to the downside. It will be hard for the U.S. to remain in expansion when so many other world centers are contracting.
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