Many economists, including those employed by the Federal Reserve, had predicted a recession this year as a result of the central bank’s decision to raise interest rates in an effort to reduce persistently high inflation.
However, the economic slump never materialised.
“A very high proportion of forecasters predicted very weak growth or a recession,” Powell stated. “Not only did that not happen, we actually had a very strong year.”
That’s excellent news for investors, consumers, and companies alike, but the sudden change in the weather begs the question, “How did forecasters get it so wildly wrong this time?”
According to analysts who spoke with Yahoo Finance, the reason is the unusual nature of the COVID outbreak and the historic $5 trillion fiscal stimulus the US government injected into the economy in response.
It’s been a huge struggle, according to Matthew Luzzetti, chief US economist at Deutsche Bank. Forecasting involves a lot of historical research, either using your models or historical parallels to determine how things are similar or different from the past and to obtain historical average responses. And it’s quite challenging when there isn’t a comparable time frame to refer back to.”
The US consumer proved to be tenacious in 2023, as seen by the fact that more individuals than predicted unlocked their wallets. That happened mostly because trillions of dollars that were injected into the economy during the epidemic gave Americans a financial advantage that many did not realise they had.
According to Luzzetti, this caused an enormous rise in surplus savings to a degree that is not often observed during recessions. The extra cash in people’s pockets caused them to spend more than one would normally anticipate following a recession, such as the one that occurred in 2020 during the early stages of the pandemic.
When you combine that with the fact that this year’s government savings forecast was revised higher, it becomes evident that consumers in 2023 were starting from a stronger position than many analysts had predicted.
According to Wells Fargo economist Shannon Seery, “we thought households were going to run out of this excess liquidity by the end of this year up until a few months ago.” “And then revisions of the data suggest that households have a bit more spending power in that capacity.”
According to recent statements made to Yahoo Finance by the economic teams at Wells Fargo, Deutsche Bank, Bank of America, EY, and Jefferies, they had anticipated that interest rates would rise sooner and more forcefully than they actually did.
In general, everything becomes more costly in an economy with rising rates. The cost of borrowing is higher for Americans. Mortgage rates are rising sharply. Also rising is the cost of funding for enterprises. This implies that in order to balance rising borrowing costs, firms must make cost reductions in other areas, such as personnel.
Thomas Simons, US economist at Jefferies, stated, “You look at these very rapid rate increases and you’re assuming that means there’s going to be these kind of catastrophic impacts on the economy.” “But in reality, both the household and the corporate sector are much more insulated from rate hikes than it appeared, and certainly than they have been in previous rate hiking cycles, based on just how they fund their activity.”
According to Michael Gapen, chief US economist at Bank of America, this kept customers “insulated” from policy. Consumers and companies had to brace themselves for a spike in borrowing costs due to the Fed’s strong actions at the beginning of the rate-hiking cycle and the industry’s repeated forecasts for a recession.
“It’s a bit of a paradox: The more cautious people become, the less likely you are to get overextended and have a downturn,” Gapen stated.
Thus, according to Gapen, “the so-called most widely forecasted recession in the history of mankind” may have contributed to the fact that the recession never materialised as many customers were well aware that interest rates would be rising.
The Bureau of Labour Statistics reports that in 2020, the US economy shed almost 9 million jobs, marking the worst calendar-year decrease ever. Due to the fact that most Americans stayed indoors to avoid being exposed to COVID, the leisure and hospitality sectors suffered the greatest damage, with several firms closing.
Three years later, this made predicting much more difficult. Higher borrowing rates were predicted by many analysts to stifle company expansion and ultimately cause the unemployment rate to rise.
However, Luzzetti notes that several of the industries most affected by the epidemic, such as tourism and hospitality, were still recovering in 2023 and helped explain the unexpected increases in the labour market. According to a Deutsche Bank estimate, 70% of the private sector’s employment growth this year has been in the leisure and hospitality industries, along with healthcare and education. If you take those out, the rate of employment creation would resemble the rate that usually comes before a recession, according to Luzzetti.
In addition to the lack of job losses that many analysts had first predicted, this year’s job growth resulted in a robust labour market and a record low unemployment rate. According to Lydia Boussour, an economist at EY, the layoffs that many had anticipated probably never happened.
Following the epidemic, businesses found it extremely difficult to reconstitute their staff and draw in the necessary personnel, according to Boussour. “And I think that was really a factor in seeing companies really holding on to their workforce and their best talent in this environment.”
In addition, consumers had more money to spend in 2023 than many had predicted due to robust pay growth and increased labour force participation.
“You’re not going to get a recession in the US economy unless the consumer takes a step back, and the consumer probably won’t take a step back unless labour markets are weakening,” Gapen stated.
Regarding what all of this means for 2024, economists are noticeably less united. Some, such as Gapen at BofA and the Goldman Sachs team, believe that the upcoming year won’t witness a recession. Others, such as Luzzetti of Deutsche Bank, continue to predict a slight recession in 2024 as businesses reduce staff in response to the Fed’s tightening drive, which would raise the unemployment rate.
Nonetheless, most people concur that the economy will be much closer to its pre-pandemic state by the end of 2023. It is the lowest point in over two years that there is between job opportunities and hiring. The labour force participation rate has returned to pre-pandemic levels, and the substantial salary increases observed in the competitive post-lockdown labour market have also abated.
All of this points to a return to normal, which is encouraging for a sector that looks to the past to predict its future.
“2024 looks like it’s an economy which is on its way to normalising,” added Luzzetti. “And hopefully one where those typical relationships that we use as economists begin to exert themselves again, and it becomes a little bit easier to forecast.”