Historical data has always been critical to those making economic predictions. But three years into the pandemic, America is suffering from something of an economic whiplash – and the past is proving to be far from a reliable guide.
Forecasts have been turned upside down time and time again. The economy recovered faster and stronger than expected from the blow it suffered at the start of the coronavirus. Commodity shortages then collided with strong demand to fuel a surge in inflation that was both more extreme and persistent than expected.
Now, after a year in which the Federal Reserve has hiked interest rates at the fastest rate since the 1980s in a bid to slow growth and bring these rapid inflations back under control, central bankers, Wall Street economists and US officials are trying to Biden administration to guess what this could be like for the economy in 2023. Will Fed Policy Trigger a Recession? Or will the economy cool down gently, curbing high inflation in the process?
With typical patterns still out of whack across much of the economy – including housing, autos and the labor market – the answer is far from certain, and past experience will almost certainly serve as a bad card.
“I don’t think anybody knows whether or not we’re going to have a recession, and if so, whether it’s going to be a deep one or not,” Fed Chairman Jerome H. Powell said during a news conference last week. “It’s not recognizable.”
Doubts about the future are one reason the Fed is recalibrating its monetary policy approach. Officials are now raising borrowing costs more gradually, giving them time to see how their policies are affecting the economy and how much more is needed to ensure inflation returns to a slow and steady pace.
As policymakers try to guess the future, the markets that have been most disrupted in recent years illustrate how big changes — some prompted by the pandemic, others linked to demographic shifts — continue to permeate the economy and forecasts at a Doing the Uncertainty Exercise.
Housing is strange.
The pandemic era has repeatedly turned the housing market upside down. The virus outbreak had city dwellers rushing for more space in suburban and small-town homes, a trend fueled by low mortgage rates.
Then post-lockdown reopenings drew people back to the cities. That has helped push up rents in major metropolitan areas — which account for a large portion of inflation — and combined with the Fed’s rate hikes, it has helped severely slow home buying in many markets.
The question is what happens next. Regarding the rental market, new lease data from Zillow and Apartment List suggest conditions are cooling. The supply of available apartments and houses is also expected to increase in 2023 as long-awaited new residential buildings are completed.
Frequently asked questions about inflation
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual change in the price of essential goods and services such as food, furniture, clothing, transportation and toys.
“The framework that I would set for 2023 is that we’re really going to go back into the year in a constrained demand environment,” said Igor Popov, chief economist at Apartment List. “We will see more apartments competing for fewer tenants.”
Mr. Popov expects “small growth” in rents in 2023, but said the outlook is uncertain and depends on the state of the labor market. If unemployment rises, rents could fall. If the workers are doing really well, rents could rise faster.
At the same time, existing leases are still catching up on the big spike that took place over the past year as tenants renew at higher rates. It is difficult to estimate how closely official inflation will match market-based rental data and how long it will take for the trend to fully take hold.
“It could be solved in months, or it could take a year,” said Adam Ozimek, the Economic Innovation Group’s chief economist.
Then there’s the condominium market, which doesn’t count for inflation but does matter for the pace of overall economic growth. New home sales have fallen off the cliff as mortgage costs and recent price increases have made buying a home unaffordable for many families. Still, new mortgage applications have surged at the slightest sign of relief in recent months, evidence that potential buyers are waiting on the sidelines.
Demographics explain this underlying demand. Many Millennials, who are around 26 to 41 years old and represent America’s largest generation, entered the home-buying age right at the start of the pandemic, and many are still in the market — which could represent a floor to how much home prices will become moderate.
Also, “sellers don’t have to sell,” said Mike Fratantoni, chief economist at the Mortgage Bankers Association, who expects home prices to remain “flat” next year as demand slows but supply has been severely limited after just a decade of underpinning the real estate crash of 2007, continues to withdraw.
With all the moving parts, many analysts are either much more optimistic or very pessimistic.
“It’s almost comical to see the forecasts for house price growth,” said Mr. Popov. “Either 3 percent growth or double-digit declines, almost nothing in between.”
The car market also remains strange.
The auto market, a key driver of America’s initial surge in inflation, is another economic conundrum. Years of undersupply have unleashed pent-up demand that is leading to unusual consumer and business behavior.
Used cars were particularly scarce at the start of the pandemic, but are finally becoming more widely available. The wholesale prices that traders pay to store their goods have fallen sharply in recent months.
But auto sellers are taking longer to pass those sharp declines on to consumers than many economists were expecting. Wholesale prices are down about 14.2 percent from a year ago, while consumer prices for used cars and trucks are down just 3.3 percent. Many experts believe this means bigger discounts are to come, but there is uncertainty as to how soon and by how much.
Understand inflation and how it affects you
The new car market is even stranger. It remains undersupplied due to parts shortages, although this is beginning to change as supply chain issues ease and production recovers. But both dealers and auto companies have made big gains in the low-supply, high-price era, and some have floated the idea of maintaining lean manufacturing and inventories to keep their returns high.
Jonathan Smoke, chief economist at Cox Automotive, believes that the normal laws of supply and demand will eventually prevail again as companies struggle to retain customers. But the return to normal will be a gradual and perhaps faltering process.
Still, “we’re at a tipping point,” said Mr. Sagte Rauch. “I think that new vehicles will always be less inflationary.”
Labor markets are the most important question mark.
Perhaps the most critical economic conundrum is what will happen next in America’s job market — and it’s a tough one to solve.
Part of the problem is that it’s not entirely clear what’s happening in the labor market right now. Most indications are that recruitment has been strong, job vacancies are plentiful and wages are rising at the fastest pace in decades. But there is a big divergence between different data series: The Labor Department’s Household Survey shows much weaker hiring growth than the Employers’ Survey. Adding to the confusion, recent research suggests revisions could make today’s labor growth look much lackluster.
“It’s a huge mystery,” said Mr. Ozimek of the Economic Innovation Group. “You have to find out which dates are wrong.”
This confusion makes it even harder to guess what’s next. If, like most economists, you accept that the job market is hot right now, Fed policy is clearly poised to cool it: The central bank has raised interest rates from near zero to about 4.4 percent this year and expects to do so to raise to 5.1 percent in 2023.
These moves are specifically aimed at curbing hiring and wage increases, as central bankers believe inflation will remain high for many types of services if wage increases remain as strong as they are now. Dental offices and restaurants will theoretically try to pass rising labor costs on to consumers to protect their profits.
However, it’s unclear how much the job market will need to slow to bring wage growth back to more normal levels the Fed is targeting, and whether it can slow sufficiently without plunging America into a painful recession.
Companies appear to be facing major labor shortages, in part as a wave of baby boomers are retiring, and Fed officials hope this will make companies more inclined to hold on to their workers even as the overall economy slows sharply . Some policymakers have suggested that such “labor hoarding” could help them achieve a soft landing that defies historical precedent: Unemployment could rise significantly without spiking any further, and the economy could cool, without plunging them into a painful downturn.
When the unemployment rate rises more than 0.5 percentage point, as the Fed is forecasting for next year, the unemployment rate usually keeps rising. The loss of economic momentum feeds on itself and the nation plunges into recession. This pattern is so established that it has a name: the Sahm rule, named after economist Claudia Sahm.
But Mrs. Sahm herself said that if the axiom were to collapse, this crazy economic moment would be the right time. Consumers are sitting on unusual savings that could help sustain middle-class spending amid some job losses and avoid a downward spiral.
“What never happened should happen,” she said. “But hey, things that have never happened have happened left and right.”