Our 2023 forecast for the US economy
Our central forecast is for a moderate US recession starting in early 2023, with annual US GDP dropping 0.2% after estimated growth of 1.9% in 2022. Having peaked at 9.1% year-on-year in June 2022, we forecast consumer price index (CPI) inflation to be close to 3% by end-2023 (the annual average CPI could drop from 8.1% in 2022 to 4.0% in 2023). We think the unemployment rate will edge up in the second part of the year.
We believe the main culprit for the expected contraction in GDP and rise in unemployment will be the Federal Reserve’s (Fed) sharp tightening of monetary conditions in an environment of fiscal policy prudence (even more so as Congress is now divided post the midterms elections). The full impact of 2022 tightening will really only be felt in the coming months.
We forecast that household consumption will grow a little less than 0.5% in 2023, down from an expected 2.6% in 2022. With the household savings accumulated as a result of the pandemic largely depleted, the key to the outlook for household spending in 2023 will be consumers’ ability (and willingness) to borrow. One silver lining is that slowing inflation may mean more purchasing power as wage growth will likely remain high by historical standards. Following the midterm elections, probability of further large spending packages looks low, unless a significant recession leads to cross-party agreement for fiscal stimulus.
We expect the Fed to hike the fed funds rate to a range of 5.0-5.25% (versus 3.75-4.0% currently) by March 2023, and then keep it there for the rest of the year. Fed messaging could remain hawkish due to sticky inflation expectations, still-high services inflation and resilient wage growth. Meanwhile, the central bank’s balance sheet will likely continue to shrink according to pre-set plans unless there is an inordinate deterioration in liquidity conditions.
Indeed, the risk to our central scenario for the US is that inflation proves ‘stickier’ than expected (especially in services) and that the Fed feels it needs to tighten more to force down demand—in which case, the recession could be deeper and longer.