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Real consumer spending at the end of 2022 was still growing at a healthy 2% year-on-year pace, writes Gregory Daco.
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About the author: Gregory Daco is Chief Economist at EY and former Chief US Economist at Oxford Economics. The views expressed in this article are those of the author and do not necessarily represent the views of Ernst & Young LLP or other members of the global EY organization.
As we enter 2023, the global economy is increasingly difficult to decipher and the consensus on a mild recession will be challenged in the coming months. The reason is simple. Although a mild recession represents a good intermediate prognosis, it is by no means the most likely.
According to one scenario, the ongoing war in Ukraine and sanctions against Russia, several years of high interest rates, depressed global stock prices, increased volatility in financial markets and a synchronized slowdown in Europe, Latin America, North America and Asia will push the global economy into recession in 2023. In in this environment, deteriorating conditions of trade, investment and financial markets would amplify the shock so that the global recession would be larger than the sum of individual regional recessions.
Alternatively, in a soft landing scenario—where economic activity cools just enough to allow inflation to fall back toward central banks’ targets—the global economy experiences a period of slower growth in the first half of the year, but emerges at a stronger pace later in the year. in the summer and until 2024.
Much ink has already been spilled on the downside risks to the outlook, so it is important to highlight three key factors that could lead to the realization of a more optimistic scenario. It is not about putting on rose-colored glasses, but about observing recent global developments with a curious eye towards the probable.
Three factors to watch closely are the relative resilience of business and consumer activity in the US, an extremely mild winter in Europe and the sudden abandonment of the zero-Covid policy in mainland China.
In the US, final demand is now visibly easing. Tighter financial and credit conditions caused by the Federal Reserve’s aggressive tightening cycle are forcing business executives to reassess their investment decisions and talent needs for 2023. But with so much effort spent on hiring and training over the past 18 months, executives are reluctant to let go of their valuable talent . As such, layoffs remain low and companies are instead considering hiring cuts along with compressing wage growth to keep labor costs in check.
The December employment report reflected this subtle easing in labor demand. The three-month moving average of job gains moderated to a respectable 247,000, hours worked fell back to pre-pandemic levels and temporary employment closed for the fifth straight month. With 4.5 million jobs added to the economy in 2022 and the unemployment rate at a 50-year low of 3.5%, the labor market remains relatively strong.
Consumer spending also showed signs of resilience. This is also true as households – especially lower- to middle-income families – use more discretion in their purchases and use savings and credit in the face of persistently elevated inflation. Real consumer spending at the end of 2022 was still growing at a healthy 2% pace compared to the previous year.
December’s figure on average hourly earnings for private sector workers will no doubt be a welcome step for Fed policymakers looking for evidence that their fight against inflation is succeeding. The combination of softer monthly wage growth, along with the lowest year-over-year post-pandemic wage growth of 4.6%, should reassure the Fed of a continued slowdown in the pace of monetary tightening — with a quarter-point rate hike likely in early February. – is guaranteed.
Evidence of easing inflationary pressures in the coming months would likely cast further doubt on the Fed’s hawkish narrative. It could even open the door to a recalibration of monetary policy that would see rates cut by the end of the year – another stimulus to growth. This could happen despite a recent statement from the minutes of the Federal Open Market Committee that “no participants anticipated that it would be appropriate to begin reducing the target federal funds rate in 2023.”
Europe, meanwhile, got an unexpected free pass with one of the warmest starts to winter in years, if not decades. While these conditions are sure to add to climate concerns, higher temperatures ease fears of a looming energy crisis as gas stocks in Europe remain high. Lower gas, oil and electricity prices are easing the cost of living for families across Europe and will support consumer spending and manufacturing activity.
Purchasing managers’ indexes across the euro area also point to a tentative recovery in activity in the services sector. With consumers and business managers less pessimistic about the outlook and regional economies finishing the year better than expected, activity may be less muted in 2023. Still, aggressive monetary tightening and hawkish communication from the European Central Bank with weak income growth argue against any premature celebrations as they point to the region’s limited economic prospects.
As the authorities in China have apparently decided that the economic benefits of quickly reversing the zero-Covid policy outweigh the costs of the health crisis, the country is experiencing an unprecedented increase in the number of Covid infections and deaths. This will severely limit economic activity in China in the near future. But while the hit to growth is likely to be significant in the near term, the government’s increased commitment to pro-growth policies, along with increased population immunity, is likely to support a recovery in employment, consumer spending and manufacturing activity in the spring and summer. .
Overall, the implication for forward-looking financial markets is that while volatility is likely to remain pervasive in the first half of the year, better market conditions may prevail once uncertainty about the immediate economic outlook dissipates.
And if the more optimistic scenario plays out, the realization that a higher interest rate environment is likely to persist along with zeroing market valuations and stabilized foreign exchange markets should lead to more transaction activity.
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