CDI Economic Summary: Winds turn positive with inflation easing, mild recession likely

Joseph Chang

25-Jan-2023

NEW YORK (ICIS)–The economic winds are shifting. With the US Federal Reserve potentially nearing the end of its rate hikes amid encouraging signs inflation is declining, Europe dodging a bullet with a record warm winter, and China reopening after abandoning its zero-COVID policy, the odds of a relatively mild recession or soft landing for the US economy have improved.

ICIS forecasts US GDP growth of just 0.2% in 2023 following an estimated 2.0% gain in a choppy 2022, with global GDP growth slowing to 1.7% in 2023 from 2.8% in 2022.

Inflation has clearly peaked and is starting to moderate, although it remains at elevated levels. China’s reopening could complicate the inflation picture.

The US December Consumer Price Index (CPI) actually fell month on month by 0.1% but was still up 6.5% year on year.  Core CPI (excluding food and energy) rose 0.3% in December – up 5.7% from a year ago.

While still far from the Fed’s 2% target, inflation is going in the right direction.  ICIS forecasts US CPI falling hard from an average of 8.0% in 2022 to 4.0% in 2023 and further to 2.4% in 2024.  Global CPI inflation is expected to moderate from 8.1% in 2022 to 5.6% in 2023.

A key leading indicator is showing weakness on both the manufacturing and services front. The US ISM Manufacturing Purchasing Managers’ Index (PMI) for December declined 0.6 points to 48.4, the second month of contraction (under 50), following 29 consecutive months of expansion. While this was no surprise, the plunge in the ISM Services PMI was – this fell 6.9 points to 49.6, the first month of contraction since May 2020.

Bad news is good news on the inflation front, especially since services inflation has been far stickier. The decline in retail sales was also encouraging, with the December figure falling 1.1% from November. The unemployment rate continues to be at an ultra-low 3.5%, but this will tick up given widespread layoff announcements.

Consensus is forming around the Fed hiking rates by 0.25 percentage points in February. The Fed in December guided to a terminal Fed Funds rate of 5.1%, implying potentially another 0.75 percentage points in hikes this year from the current range of 4.25-4.50%. If the Fed does hike after February, it will be at a much more measured pace.

Meanwhile, the ICIS US Leading Business Barometer (LBB) suggests conditions consistent with recession.  In the latest January reading, the LBB fell 0.6% month on month and is down 7.9% from a year ago.

This downturn or recession, if we get one, may be different as housing and automotive – typically compounders of pain to the downside – could prove resilient with auto sales in particular actually rising.

While housing peaked in 2022 and is in decline with affordability eroded by high prices and borrowing costs, demographics should be a tailwind. Millennials at prime homebuying ages of 30-40 have very low home ownership rates compared to baby boomers, and there’s been over a decade of underinvestment in housing following the financial crisis of 2008-2009.

Thus, there is likely to be a floor in housing starts, which ICIS projects falling to 1.24m in 2023 from an estimated 1.56m in 2022 – down slightly from 1.29m in pre-pandemic 2019.

In automotive, the supply chain issues around semiconductors and other components have largely been resolved. Dealer inventories were just under 26 days in December – up from the low of about 15 days in May but still 60% below pre-pandemic levels.

ICIS projects US light vehicle sales rebounding to 14.8m units in 2023 from 13.6m in 2022 – still well below 17.0m in pre-pandemic 2019.

This year will be no picnic as the weight of the Fed’s massive rate hikes in 2022 take hold and inflation is far from dead. However, green shoots of optimism are emerging and 2023 may not be as bad as once feared.

Additional reporting by Kevin Swift, ICIS senior economist for global chemicals

Thumbnail shows money. Image by Al Greenwood.

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