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Outlook: 2023 Recession Likely Deeper and Longer

Last year, our year-end outlook blog was titled: Outlook: 2022 Growth Will Likely Disappoint. And disappoint, it did. Real GDP was negative in Q1 and Q2, and while Q3 showed a slight bounce, through Q3, the economy’s annualized real growth was less than +0.2% (that’s not a typo). Thus, last year’s outlook headline couldn’t have been more prescient!

The equity markets sang the blues all year, with peaks occurring in the indexes in late 2021 or very early last January. Note from the table that the growth sectors (Nasdaq) were down significantly more than the value ones (DJIA).

The fixed-income markets also sang the blues. It’s unusual for both bond and stock markets to move in the same direction price-wise. This year’s move down in both was caused by very poor monetary policy management, first keeping interest rates far too low (near 0%) for far too long, then monetizing the “free money” from Congress (money supply (M2) growth above 25% in 2021), then suddenly finding religion and significantly over-repenting by raising rates too far and too fast, and by contracting the money supply. Now, the Fed has turned a blind eye to the progress already made against inflation and to the lagged impact of monetary policy on the economy.

We believe that when the National Bureau of Economic Research (NBER) decides to date this Recession, Q1/22 will be the starting quarter. As the Real GDP data shows, in 2022, we just experienced a flat (no growth) economy (at least through Q3). We think 2023 will show contraction as monetary policy acts with a lag, and we are just now seeing the tip of the iceberg:

  • Delinquencies are on the rise in the consumer loan, credit card, auto, and mortgage spaces.
  • Banks are experiencing deposit outflows, and their new lending has slowed down to a crawl (+1.7% annualized rate from September to November vs. +12% at the end of 2021). (What the heck, the Fed is paying them 4.25%+, why lend in an environment where repayment is not guaranteed?)
  • Bloomberg recently reported that $650 billion of bonds and notes are in distressed condition.
  • The Conference Board’s Leading Economic Indicators (LEI) (left side of the chart) have fallen nine months in a row and in 10 of the last 11. History tells us that whenever such a negative pattern has occurred, 100% of the time, a Recession follows. On the right-hand side of the chart, the negative trend in the NY Fed’s weekly index has continued.
  • Manufacturing has slowed and soon will be showing contraction. Industrial Production in November only grew because utility output was up as a result of unseasonably cold weather. The chart above shows the downward path of the ISM Mfg. Index (-3.0 M/M November), and an average of the NY and Philly Fed Indexes. Those indexes are showing contraction.
  • The money supply, always critical to the economy’s growth, has grown 0% on a Y/Y basis (after double-digit (inflationary) growth in 2020 and 2021) and is destined to turn negative as the Fed continues its Quantitative Tightening (QT), selling Treasuries and Mortgaged Backed Securities from its portfolio and reducing bank reserves (another reason bank lending is disappearing).
  • Fed-Ex recently reported a -10% Y/Y fall in their average daily delivery volumes in 2022, which is not good news for retailers. On the positive side, there has been an easing of the labor constraint as “on-time” performance in 2022 has risen to 95.3% from 83.9% in 2021.
  • Maersk, the large worldwide shipping company, has forecast that container demand will fall -4% in 2023.
  • Retail inventories are +19.8% higher than a year ago; one can expect heavy discounting in the months ahead (a positive sign for inflation!).
  • We have noted in past blogs that Challenger Gray and Christmas reported significantly rising layoffs. On Thursday (December 29), the Department of Labor’s weekly release showed that for the week of December 17, insured unemployment rose 41K to 1.71 million. And while anecdotal, the fact that Wall Street powerhouse Goldman Sachs has announced layoffs (we understand 8% of their headcount) is eyebrow-raising.
  • All the Regional Federal Reserve Bank Surveys are reporting much weaker hiring trends. A composite of those employment indexes now stands at -2.2 (December), the first time this composite has been negative since the May 2020 lockdowns.


As we have reiterated in this blog, housing is the most interest-sensitive sector. The latest data confirming that housing is already in Recession is Pending Home Sales (left-hand chart). It came in at -4.0% M/M (November). October was also down -4.7%. On a Y/Y basis, Pending Home Sales are down a whopping -38.6%. This is the largest Y/Y decline in the 20-year history of the index.

Given the weakness in sales, it isn’t a surprise that housing prices are now falling. The chart (S&P Case-Shiller Index – right-hand chart) shows that on a Y/Y percentage basis, prices are up 8.6%. But this is much improved over the +20% readings earlier in the year. As in the Great Recession, we expect the Y/Y trend to turn negative soon.


As the economy slip-slides into the Recession, the inflation data continue to improve. The PCE deflator, the one the Fed watches most, rose a mere +0.1% M/M (a 1.2% Annual Rate). This is the second weakest reading since November 2020. The Y/Y rate, which the Fed is fixated on (i.e., driving by looking through the rear-view mirror), fell to +5.5% Y/Y in November from +6.1% in October. The six-month annualized rate is +4.0%, and the three month is +3.3% (moving in the right direction). The core (excludes food and energy) rose +0.17% in November, a fall from October’s +0.26%. On a Y/Y basis, the core rose +4.7% in November vs. +5.1% in October. Of importance, in the aggregate, the prices of goods (whose shortages began the current inflation) fell -0.4% in November and have fallen in four of the last five months. As for services, those prices rose +0.35%, the lowest rise since July; services prices now appear to have peaked.

It is also notable that the various inflation gauges monitored by the Regional Federal Reserve Banks (Cleveland, Dallas, NY, and St. Louis) all moderated in November and have been doing so for six months or more. For example, the Cleveland Fed’s five-year inflation expectation gauge fell to 2.27% from 2.53%. So, no, inflation expectations are not becoming unanchored as the Fed has feared. We wonder if the FOMC is listening to their own Regional Banks!

And as for the rise in the cost of shelter issue (i.e., rents), those too are now falling and will continue to do so as apartments under construction are at highs not seen since the 1970s. The BLS’s method for measuring shelter inflation is antiquated, and we won’t see the deflation that is already with us appear in the CPI until mid-2023 (chart). The FOMC certainly knows about this calculation issue.

Final Thoughts

As seen from the table at the top of this blog, the equity markets performed poorly in 2022. Unfortunately, the Recession, so far, has only been nasty to the housing industry. In addition, Wall Street analysts still expect 2023 S&P 500 earnings to rise by 7%. As such numbers begin to reflect reality and come down to earth, equities will continue to languish. The fixed-income markets, on the other hand, are interest rate sensitive. Given the unfolding data, we see the Fed raising 25 basis points at its January 31-February 1 meeting and “pausing” thereafter. When they actually “pivot” (i.e., cut rates) depends on the depth and duration of the Recession. While short-term rates are pegged to Fed policy, long-term rates are more sensitive to the economy, and we think those long-term rates have already peaked. We conclude with the acronym “BAAA” (Bonds Are An Alternative). (It’s okay to say it out loud!)

Robert Barone, Ph.D.

(Joshua Barone contributed to this blog)


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