The U.S. economy heads into 2023 facing what might be the most anticipated recession in history. After all, everyone knows a contraction is coming. Following a year spent fighting runaway inflation that resulted in the Federal Reserve jacking up interest rates to slow the economy, there’s really no alternative. Consumers are retrenching, companies are announcing layoffs and most Wall Street economists see a period of negative growth coming. So that means a recession has to be in the cards . Right? Not so fast. Yes, growth is likely to trudge through mud much like it did in 2022. But slow growth doesn’t mean no growth, and it doesn’t mean negative growth is a certainty. “Next year under any scenario will be a tough year, a struggle,” said Mark Zandi, chief economist at Moody’s Analytics. “Odds are, with a little bit of luck and some deft policymaking, we will avoid an outright recession.” Fear of the Fed There’s a lot to unpack in Zandi’s statement, particularly the latter part. First, about that idea of “deft policymaking” at what appears to be a crossroads for the nearly $26 trillion U.S. economy. It’s the machinations of policy that have upset investors the most this year, and what poses the greatest danger — and opportunity — for what’s to come. Fiscal and monetary policy went from being a massive tail wind in 2021 to a major headwind in 2022, and is a huge question mark for 2023. Investors worry that the central bank’s aggressive efforts to bring down inflation will slow the economy so much that a contraction will occur. After whiffing badly on its inflation outlook in 2021, the Fed boosted benchmark interest rates by 4.25 percentage points this year through a series of increases that began in March. It’s the most tightening the central bank has implemented since the early 1980s, which not coincidentally was the last time inflation was this high. Fed Chair Jerome Powell has been clear that rates will go up and stay up until there are “substantial” moves showing that inflation has been arrested. But he’s also been circumspect about what exactly would constitute substantial progress, so that has created a great unknown as to just how tight monetary policy will be. The second part of Zandi’s quote also is meaningful: What constitutes an “outright recession”? To some, the two consecutive quarters of negative growth that began 2022 were enough to say the U.S. was in recession, as they met the long-held conventional definition. But no recession has seen the kind of job gains witnessed throughout 2022 — averaging nearly 400,000 a month — so it’s widely doubted that the National Bureau of Economic Research, considered the unofficial arbiter of expansions and contractions, will be calling the 1.6% and 0.6% respective declines in the first quarter and second quarter a recession. I actually feel more optimistic today about no recession than I have in quite some time.” Moody’s chief economist Mark Zandi Zandi said he thinks a resilient labor market and a sturdy consumer still armed with purchasing power also could keep 2023 out of the red. “Consumers are hanging tough. They don’t need to spend in abandon, they just have to do their part,” he said. “I actually feel more optimistic today about no recession than I have in quite some time.” But Zandi acknowledged there’s not much on the positive side to look forward to next year even if the U.S. skirts the actual recession designation. He’s plugging in growth in gross domestic product of just 0.9% for the year — positive but just barely and not representative of an economy that will inflict some widespread pain following the boom of 2021, when a post-lockdown rebound resulted in the highest GDP growth since 1984. Essentially, the economy breaks into three possibilities for 2023, each largely dependent on how far the Fed has to go to quell inflation: The bull case has a resilient consumer, falling inflation and a central bank that doesn’t have to tighten the economy into a recession. The result is solid — if unspectacular — growth. The bear case: A retrenched consumer and a Fed that has to be even more aggressive to bring down stubbornly high inflation results in heavy job losses and a recession worse than the “shallow” contraction many economists have predicted. The central forecast for Wall Street looks like this: The Fed raises rates and keeps them there, pretty much in line with market expectations, resulting in a mild downturn, some loss of jobs but not the “hard landing” that policymakers fear. What a recession could look like Few if any of Zandi’s economist colleagues are feeling much better about what’s ahead. One possibility for the economic climate is what Joseph Brusuelas, chief economist at consulting services firm RSM, calls a “nonsynchronized recession.” That basically means some parts of the economy will feel like they’re in a recession while others won’t. It’s a fairly popular view among economists who feel that we’re living in unique times where the benefits and costs of policy moves are not evenly distributed. “Some areas of the economy may not feel like they actually are in recession. It’s just going to approximate slow growth,” he said. “The only reason I’m going to call it a recession is we’ll see over 1 million jobs lost next year.” That’s not by accident. The Fed is specifically targeting the red-hot labor market and its accompanying wage surges as a major pressure point for inflation. Central bank officials hope that a projected rise in the unemployment rate to 4.6% from the current 3.7% comes about mainly through a softening of demand rather than mass layoffs. But Powell has acknowledged that solving inflation will likely result in “some pain” for Americans . That weakening jobs market will be part of what Michelle Meyer, chief U.S. economist at the Mastercard Economics Institute, calls a “bifurcated economy, where it feels different depending on how you participate.” “For certain parts of the economy, it will feel like a very deep recession. For other parts, it will feel like a healthy growth economy, particularly in the parts of the economy where we see strong demand,” she said. Big durable goods such as appliances and TVs will be weaker, Meyer explained. Electronics and home sales also will display continued vulnerability, as will autos, she said. On the healthy side, “experiences” such as travel, restaurants and other leisure-related spending “seem to be the big winner now,” she said. “The consumer still has purchasing power. But it’s not as powerful as it was to start out 2022, which means consumers will have to make choices. That means aggregate consumer spending is set to slow,” Meyer said. “What we have observed is a much more emotion-driven consumer.” Low confidence, high spending The consumer’s feelings took a substantial hit in 2022 due to runaway inflation topping out around a 9% annual rate in the summer, the worst in more than 40 years. Still, fueled by trillions in excess savings due in good part to generous fiscal and monetary pump-priming during the pandemic, consumers kept on spending. Retail sales grew 6.5% from a year ago, fed by heavy spending at gas stations (up 16.2%) and bars and restaurants (up 14.1%), according to Commerce Department data through November that is not adjusted for inflation. It happened even as consumer confidence hung around record lows for much of the year. “Their balance sheet is strong,” Meyer said. “That’s why we are in the camp that the economy avoids an outright recession. Instead, we see a stalling of real economic growth next year, below trend, but not an outright recession.” Meyer said she expects GDP growth of 0.2% in 2023 — not much, but growth nonetheless. The big wild card in all of it, of course, is the Fed. Mid-December projections from officials on the rate-setting Federal Open Market Committee pointed to a few more hikes in 2023 before the benchmark interest rate hits 5.1%, which would equate to about another three-quarters of a point in increases. Markets, though, think the Fed will be less aggressive, with the rate topping out around 4.75% before it is forced to lop at least a quarter point off by year-end, according to CME Group data . A cut implies a market belief that the economy will slow so much and inflation will cool enough that policymakers can start easing, if only a little bit. “The Fed is probably going to continue raising interest rates as they’ve signaled through early 2023. But the pivot will likely come before the end of next year,” said Comerica chief economist Bill Adams, who sees GDP declining by 0.25% over the next year. “The bar for the Fed to ease is very high right now. … There are a lot of boxes for them to check before they feel comfortable with beginning to reduce rates.” Focusing on the positive The year is ending with some encouraging news on the inflation front. The Fed’s favorite inflation measure, personal consumption expenditures prices less food and energy, declined in November on a 12-month basis to 4.7% , tied for the lowest level since November 2021. A more widely followed measure, the core consumer price index, rose 6% annually in November, down from 6.6% in October, also an improvement. The bad news is that both are still well above the Fed’s 2% target level, but at least the trend is moving in the right direction. Taming inflation without sending the economy into a death spiral is at the center of perhaps the most bullish call on Wall Street, courtesy of Goldman Sachs. The investment bank’s economists think the Fed will implement another 0.75 percentage point — 75 basis points — worth of rate hikes before stopping. In the meantime, they see the jobless rate increasing only incrementally to “just over 4%” from the current 3.5%, with about 1% growth in U.S. GDP. “Our most out-of-consensus forecast for 2023 is our call that the U.S. will avoid a recession and instead continue progressing toward a soft landing,” Goldman’s David Mericle and Alec Phillips wrote in a recent client note. The firm sees below-trend growth as the best way to fix a labor market out of whack, with nearly two open jobs for every available worker . Goldman expects the 5.1% annual increase in worker wages as of November to ease in 2023, taking pressure off inflation. But Goldman does not see the Fed cutting rates until inflation is well in check. “We are skeptical that the FOMC will cut the funds rate until the economy is threatening to enter recession, and we do not expect this to happen next year,” Mericle and Phillips wrote. CNBC Pro’s guide to investing in 2023 Oil expected to stay volatile in 2023, but the price could depend on China reopening Wall Street’s biggest investors are all but sure of a recession next year. Here’s where they are hiding out Top Wall Street strategists see a bumpy 2023 ahead with minimal returns for stocks Here’s why 2023 could be another solid year for dividend stocks — and how to play it That’s why 2023 will be a year of uncertainty. War raging in Ukraine is an ever-present threat to oil prices, Covid-19 has shown it still can spring up unexpectedly and cause havoc, and the Fed is in conflict, with a battle between hawks and doves on how tough monetary policy should be when confronted with the dual threat of a slowing economy and persistently high inflation. While there are plenty of things that can go right — resolution in Ukraine, an arms deal with Iran and receding inflation — there’s little room for error. “There are things that can go off the rails that you can’t forecast,” said Zandi, the Moody’s economist. “You talk about things that can go wrong — there are two sides to that. They could go wrong, but they could also go right.”
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