Written for Bolton by Zack Fritz, Sage Policy Group
On October 17, 2022, Bloomberg published a story with the headline, “Forecast for US Recession Within Year Hits 100% in Blow to Biden.” Presidential implications aside, it’s now one year later, and there’s still no sign of a recession.
In fairness to Bloomberg, they weren’t alone in predicting a downturn. In the Wall Street Journal’s October 2022 survey of professional economists, the average forecaster put the odds of a recession over the next 12 months at 63%, and even the respondents who thought the U.S. would dodge a downturn underestimated the economy’s growth potential in 2023. What went right for the economy (or wrong from the forecasters’ perspective)?
First, the rapid interest rate increases that started in March 2022—a period of tightening that has thus far seen the upper range of the federal funds rate rise from 0.25% to 5.5%—have had shockingly little impact on the consumer side of the economy; Americans’ spending on retail and restaurants has outpaced inflation over the past year and, as of September, has increased in each of the past six months.
Much of this persistent strength is due to the number of households that locked in low-rate mortgages during the first several quarters of the pandemic. At the start of 2020, just 3.7% of mortgages had rates under 3%. Two years later, when the Fed first began raising rates, that share had increased to nearly 25%, by far the highest level on record.
Despite the ensuing surge in mortgage rates, which as of this writing are flirting with 8%, homebuying activity dissipated so quickly that the composition of mortgage debt remained frozen. Even in the second quarter of 2023, 60% of mortgages were still locked into rates under 4%. For those households, higher interest rates have had little to no impact on their finances, and their ongoing spending has propped up the demand side of the economy.
The second dynamic that forecasters failed to anticipate is the speed with which inflation, which peaked at a 9.1% annual rate in June 2022, could subside without a corresponding rise in unemployment, which as of this writing remains below 4.0%. Simply put, supply chains improved faster than anyone thought possible. Global container shipping costs, for instance, have fallen more than 90% since the peak in late 2021, according to the Freightos Baltic Index. That has alleviated supply-side price pressures even while domestic demand remains slightly overheated.
Economists have now pulled back on their recession calls. Bloomberg has probably scrapped the model that puts the odds of a downturn at 100%, and the median forecaster in the most recent Wall Street Journal survey put the odds of a recession over the next 12 months at exactly 50%, a strong indication that outlook is deeply uncertain heading into 2024.
The economy grew at a rapid clip in the third quarter and, barring a government shutdown, will continue to expand through the end of the year, but there are an unusually high number of risks that could diminish momentum during the early parts of 2024. Commercial real estate debt is coming due, and the beleaguered office sector still represents a significant risk for the banking sector. Credit card debt remains low by pre-pandemic standards but is rising, and those that do fall into delinquency now face historically high-interest rates. And then there’s ongoing political dysfunction and rising geopolitical uncertainty, both of which are particularly difficult to account for in economic forecasts and could negatively impact the economy in a number of ways.