Economic & Credit Outlook
The U.S. economy rebounded in
the second half of 2022 after contracting slightly in the first
half. Although data for the fourth quarter is not yet available, we
expect real GDP to expand by about 0.5% in 2022 (Q4/Q4), far below
2021’s 5.7% gain. Strong business investment and moderate gains in
consumer spending offset a plunge in residential investment.
Inflation intensified, reaching levels not seen since the early
1980s, and prompted the Federal Reserve to hike the federal funds
rate by 4.25% from March through December. In turn, yields on
Treasury securities rose sharply across maturities. Credit quality
remained good, but recession fears pushed credit spreads wider.
Higher interest rates and wider credit spreads combined to produce
negative returns on corporate and high yield bonds and preferred
and contingent capital securities in 2022.
Nonfarm payroll employment
expanded by an average of 408,000 jobs per month over 12 months
ending in November 2022—a very strong pace of job growth. Labor
demand pushed up average hourly wages by 5.1% YoY in November,
producing a 6.2% jump in wage and salary income, though a slowdown
in other income categories and high inflation left real disposable
personal income down 2.5%.
Personal consumer expenditure
(PCE) rose 2.0% after inflation, as consumers tapped savings to
support spending that outpaced income. With the savings rate at
just 2.4%, we see little room for further cuts to savings and
expect PCE growth to moderate in 2023, although continued strength
in wage and salary income and lower inflation may keep real
spending near its current pace in the first half.
Real business investment was a
highlight, up 4.7% at an annual rate through the first three
quarters of 2022. With workers hard to find and wages up,
businesses increased investment to improve productivity. We expect
growth in business investment to moderate in 2023 but remain
In contrast, real residential
investment plunged 16.6% annualized over the first three quarters
of 2022 as two years of rapid home price gains starting in mid-2020
collided with higher mortgage rates in 2022, sharply reducing home
affordability. Combined new and existing home sales in November
were down by almost a third from December 2021. After peaking in
June, home prices have declined and probably have further to go.
However, although activity is down sharply, we do not expect a
housing bust. Most borrowers bought their homes at significantly
lower prices, locked in much lower mortgage rates, and were better
qualified to service their debt than during the 2008-2009 financial
crisis. Residential investment is likely to remain weak in 2023,
but with home sales already down sharply, we expect the pace of
decline to moderate over the year.
Other sectors of the economy
were mixed. Real government spending was little changed through the
first three quarters of 2022 as pandemic-related programs wound
down. Net exports had almost no impact on GDP growth in the first
half of 2022 but contributed most of Q3’s 3.2% gain. Finally,
inventories were a consistent but modest drag on growth in 2022.
Looking ahead, we expect moderate real growth in government
spending in 2023, little contribution from inventories, and
moderate drag from trade.
Inflation soared in 2022 to the
highest levels since the early 1980s, accommodated by earlier
expansive monetary and fiscal policy. Supply chain bottlenecks from
the pandemic and a boom in demand from consumers pushed up goods
prices in 2021 and early 2022. Services prices followed as
consumers shifted spending back toward services in late 2021 and
2022, while the war in Ukraine boosted food and energy
In response to both easing
supply chain pressures and tighter monetary policy, inflation
should decline significantly in 2023. Already, goods prices have
slowed sharply, but services inflation has been stickier. While we
are confident that goods inflation will slow quickly, labor supply
remains tight, and it may take a recession to bring down services
inflation more meaningfully, which we do not expect until the
second half of 2023.