Economic data sent mixed messages in late 2022. Nonfarm payroll employment surprised to the upside in November with a solid 261,000 increase, and the unemployment rate held near a half-century low. In the same month, though, continued jobless insurance claims rose 28% from half a year earlier. It would be very unusual for the US to be in recession amid such strong payrolls growth.
On the other hand, in data going back to the 1960s, continued jobless claims have only risen this quickly during recessions. It is a coin toss as to whether the committee of academic economists who determine the dates of business cycle turning points ultimately decide the US economy was in a recession in late 2022 or not.
Either way, a recession looks to be a four in five proposition by the end of 2023. The US economy is facing big headwinds from surging interest rates, high inflation, the end of fiscal stimulus, and weak export markets abroad. Businesses have turned cautious about adding to inventories and hiring, and will likely delay construction and other capex plans with credit more expensive and order books shrinking. The unemployment rate will likely rise, albeit by less than in a typical recession.
Job openings are still very high, and many employers are entering 2023 shorthanded. As a result, many workers who lose jobs will find new ones relatively quickly, limiting the rise in unemployment. Others will take early retirement and exit the labor market. Even so, the 2022 job market in which workers largely held the upper hand will likely give way to one with more balance between workers and employers in 2023. By the end of next year, wage growth will likely slow to a rate in line with the pre-pandemic trend.
Inflation was terrible in 2022, but should be much less of a problem in 2023. Supply chains are working better, business inventories are up, and pandemic-related shortages are largely resolved. Prices of fuels, metals, construction materials, and durable goods are mostly flat to down over the last few months, as are house prices and rents across most of the country. CPI will likely slow to around 3% by the end of next year—a big improvement, though still above the Fed’s inflation target.
The Fed pivoted on a dime in 2022 from a full-throttle quantitative easing program to rapidly shrinking the balance sheet, raising short-term rates 4.25 percentage points along the way. They will probably make two final rate hikes of a quarter percentage point each in early 2023, raising the federal funds rate target to 4.75%-to-5.00%.
Inflation will probably slow to under 5% by next spring, below the policy rate—historically, that has been the signpost of a peak in the rate hike cycle. There are still big uncertainties about the inflation outlook, though. Russia-Ukraine, China’s stop-start economic reopening, or changes in inflation expectations since the pandemic could make the Fed hold rates higher for longer, while downside risks to global growth could push them to cut earlier or by more.
Bill Adams is senior vice president and chief economist at Comerica. Waran Bhatruethan is a vice president and senior economist at Comerica.