How trade-offs will define the economy in 2023

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The pandemic and the associated macroeconomic policy response have created some outsized imbalances in many economies. How households, businesses and policymakers respond to the tradeoffs they face will collectively determine economic performance in 2023.

Rising demand coupled with constrained supply has pushed inflation in the United States to its highest level in decades. The Federal Reserve now faces an uncomfortable dilemma: the FOMC needs to keep raising rates to ensure inflation falls back on target, but excessive tightening could result in a recession. We believe the FOMC will make the mistake of cutting inflation at the expense of a US economic slowdown in 2023.

Inflation has eroded real personal income in the United States. Still, American households have been able to sustain solid spending growth by reducing savings rates and taking on more credit card debt. Granted, these trends could potentially continue in 2023, but we expect consumer spending to usher in a period of restraint.

Some households are having to decide between buying a home, which has become less affordable due to rising mortgage rates and skyrocketing house prices since the pandemic began, or renting, whose costs have also skyrocketed. Your residency decisions will help determine the economic outlook in many regions of the country.

Businesses have struggled to find skilled workers in recent years and are understandably reluctant to oust them. But we’re on the lookout for many companies eventually cutting capital spending and slashing labor costs to protect margins, which are being squeezed by increased labor costs and slowing demand.

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The central banks of many foreign economies face the same dilemma as the Federal Reserve. That means they too need to bring inflation down from multi-decade highs, but excessive tightening could lead to a recession. Like their counterparts at the Fed, we look for foreign central bankers who decide to reduce inflation. Therefore, we forecast that many foreign economies will be in recession in 2023.

The US dollar has appreciated against most foreign currencies in 2022 and we expect this trend to continue early next year. However, as market participants begin to anticipate eventual monetary easing in the United States, we believe the greenback will trend lower from mid-2023.

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