As we surpass the halfway mark of 2023, the lingering question remains whether a recession is on the horizon. Current short-term interest rates are now higher than long-term rates. Historically, that relationship has been a recession indicator.
Interest rate increases implemented by the Federal Reserve from March 2022 through May 2023 have dramatically raised the Federal Funds Rate from 0.25% to 5.25% currently. Normally, higher interest rates quickly reduce the demand for houses and auto-mobiles that are typically financed. As a result, declining sales lead to layoffs in residential construction and manufacturing and consumers spend less. However, presently that is not the case. Demand for cars, pent up going back to the pandemic period, remains strong. In addition, fewer homeowners are listing their homes for sale, instead electing to hang on to their properties purchased with very low mortgage rates over the past few years before the current interest rate boom.
Labor market conditions remain very tight. Wage growth continues to be elevated. Over the twelve months ended May 2023 average hourly earnings for all employees averaged an increase of 4.3% (down from a peak of 5.9% in early 2022). The unemployment rate remains near historically low levels at 3.7% and is forecasted to reach 4% by the end of 2023. Supply and demand in the labor market is becoming more balanced with the prime age labor force participation rate increasing in recent months along with reduced quit rates.
Consumer price inflation has come down since 2022, with easing in consumer energy prices and food prices. However, inflation remains elevated, running in the 4.5% range, well above the Federal Reserve Board’s target of 2.0%. As a result, the Fed is expected to continue raising interest rates. Many forecasters expect at least two more quarter point rate hikes before the end of 2023.
In the credit market, borrowing costs for businesses, households and municipalities have increased notably. Steep increases can be found in the rates for 30-year mortgages, auto loans and credit cards. Although credit is readily available for borrowers with high credit scores, economists anticipate the further tightening of bank credit.
Given the continued strength in labor market conditions and the resilience of consumer spending, the economy is expected to continue to grow slowly. Gross Domestic Product growth is forecast at 1.7% for 2023 and 0.8% for 2024.
Keep in mind that should events unfold in a manner that weakens the economy and prompts a recession, not all is lost. Recessions are part of the normal economic cycle and ultimately lead to growth and expansion after bad debts and weak businesses are cleared out. In the business world, as in nature, it truly is survival of the fittest.