Upward Economic Trend Signals Potential for Additional U.S. Rate Hikes in 2023
The U.S. Economy: Stronger than Consensus
As an opinionated journalist, I remain bullish on the U.S. economy, with a more optimistic outlook than most. While some may fear a potential recession, our analysis does not foresee one. We estimate the probability of a recession to be at just 25% for the next two years. Our reasoning for maintaining such optimism follows based on the latest data available.
Stronger GDP Growth, Lower Inflation
Our more optimistic stance is based on stronger-than-expected GDP growth and lower current inflation levels. In the short term, the economy is proving more resilient than initially anticipated – even with a tightening monetary policy. The Federal Reserve, in response, continues to hike rates.
Our updated GDP forecast is optimistic due to the strong jobs and retail sales reports from January 2022. WAs a result, we project a GDP growth rate of 1.4% for 2023, 1.7% for 2024, and higher rates through 2027, resulting in 3% to 4% more real GDP growth than consensus.
Although a recession may be short-lived, we expect GDP growth to rebound strongly from 2024, fueled by supply-side expansion, including labor force expansion and productivity gains. With such an optimistic trajectory, we believe whether a recession will occur misses the larger point.
Moving Toward A Fed Pivot to Easing
The last year saw interest rates skyrocketing as the markets built expectations of monetary policy tightening. WAs a result, we’ve recently revised our forecast, raising the expectation of the federal funds rate to 4.92% and a 10-year Treasury yield to 3.75% for 2023.
Despite the adjustment, we believe rates will soon peak, and the Fed will start cutting rates aggressively by the end of 2023. Then, as inflation normalizes and shoring up GDP growth becomes more critical, we anticipate that lower interest rates will be needed to prevent a more severe downturn in the housing market.
Although the economy is currently weathering the impact of interest rates better than initially anticipated, we still expect that many lagged effects of rate hikes will weigh on the economy in 2023.
Inflation: A Battle Won
A hotter-than-expected economy prompted us to raise our inflation forecast slightly for 2023. Still, we anticipate that inflation will end the year roughly in line with the Fed’s expectation of 2%. The easing of supply constraints, combined with Fed tightening, is winning the battle against inflation.
We expect inflation rates to peak at 6.2% in 2022, dip to 3.2% in 2023, and fall substantially for an average inflation rate of 1.9% through 2023-27. While we know that some industries may experience a large spike in prices due to the pandemic, we believe that these sources of inflation will eventually unwind with aggressive capacity expansion.
- The Federal Reserve raised interest rates six times between 2015 and 2019.
- The COVID-19 pandemic has caused supply chain disruptions that have led to price increases across various industries.
- Even with a tightening monetary policy, the U.S. economy is proving more resilient in the short term than initially anticipated.
- A recession appears unlikely, and any that should be short-lived, with GDP growth rebounding strongly from 2024.
- The Fed is expected to implement a pivot back to easing from late 2023 to prevent a more severe downturn in the housing market.
- Inflation should peak in 2022 but fall substantially by 2023, with many sources of inflation unwinding via aggressive capacity expansion.
Our analysis supports an optimistic view of the U.S. economy, with lower inflation and stronger GDP growth. While the economy may face some headwinds from monetary policy tightening, we believe that the lagged effects of rate hikes will be short-lived.
Our priority is to observe the Federal Reserve’s monetary policy closely and adjust our predictions accordingly. However, on balance, we remain optimistic about the potential for GDP growth and believe that the U.S. economy is capable of a soft landing in the near term.