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GDP and Jobs Running Stronger-Than-Expected, But Recession Warning Signs Are Flashing Red, Too;
the Fed Nears the End of the Rate Hiking Cycle
Recent economic data have been mixed. The highest-profile economic indicators were much stronger than expected at the turn of the year. Real GDP surprised to the upside in the fourth quarter of 2022, growing 2.9% annualized. Then payroll employment surged 517,000 in January, job growth since early 2021 was revised up by over a million, and the unemployment rate fell to a new half-century low of 3.4%. A recession would be unprecedented while the labor market is strengthening so dramatically.
On the other hand, it would be unprecedented to avoid a recession when the most reliable indicators of business cycle turning points are flashing red—as they now are. This includes a deeply inverted yield curve; sharp declines in the Leading Economic Index and business fixed investment; and rising layoffs, continued jobless claims, and inventories of unsold new homes. Triangulating between these conflicting data, the economy is probably on course for positive growth this year, but likely interrupted by a relatively short and mild contraction. After inventories rose sharply late last year as wholesale and retail sales fell, real GDP is likely to turn negative in the first half of 2023 as businesses add to inventories more slowly (slower inventory growth subtracts from GDP).
The inflation outlook is clearer, and mostly upbeat. Wholesale prices of energy, metals, building supplies, and basic foodstuffs have mostly come down since mid-2022, helped by mild winter weather and big slowdowns in global housing and manufacturing. Durable consumer goods prices are lower, too; shortages are largely resolved outside of autos, and many consumers have reined in discretionary spending as inflation strained their household budgets. Shelter inflation will cool with housing prices falling. Wage increases slowed in January, making a wage-price spiral a less immediate risk. But inflation of non-shelter services is still too high, things like car repairs, daycare charges, veterinarian fees, and kids’ music lessons. The Fed is worried that persistently high increases of these sticky prices will hold inflation above their target after the big price swings affecting other parts of the consumer price basket normalize. Also, the Fed is very worried that the job market could overheat and push trend inflation even higher.
After January’s hot jobs report, the Fed will almost certainly raise the target rate another quarter percentage point at the next meeting in March. But the picture after that is murkier. Job growth is likely to cool soon, since layoff announcements rose in January to around their average in 2009, a year in which payrolls averaged a 420,000 monthly decline. The Fed is a bit likelier to end their rate hikes in March than to push rates even higher. But the decision is a near toss-up and will depend on whether the warning signs of an economic slowdown are correct, or whether the January jobs report marked the beginning of an unexpected reacceleration of the job market.
For a PDF version of this publication, click here: February 2023 U.S. Economic Outlook
