Already, this year looks as complex as 2022. Rates rising, inflation cooling, the debt ceiling looming, recession imminent, and labor markets mixed. Key for corporate finance leaders will be anticipating which economic forces are ascendant and which are waning.
Bank of the West Chief Economist Scott Anderson says there are trends emerging that finance teams should focus on to succeed in the months ahead. Read his thoughts in this first installment of our series What’s Next in 2023.
What indicators are you watching right now?
INFLATION IS ALREADY COMING DOWN.
The Fed needs to bring inflation down. They’re using the sledgehammer approach via aggressive rate hikes and quantitative tightening, and we’ve seen a positive inflationary response already.
Goods inflation is already coming down sharply, and we think eventually we’ll see some improvement even in housing and rent growth, and on services. Corporations are already seeing reduced prices for their inputs. A survey of purchasing managers showed that those prices actually contracted at the end of 2022 for the first time in more than two years.
GLOBAL SUPPLY CHAINS ARE ALMOST BACK TO NORMAL.
Global supply chains are almost back to normal. Last year we had 30, 40, sometimes 50 ships waiting to offload at the ports of LA and Long Beach. Now it’s one or two ships at most, and the price for a shipping container from China to the West Coast of the United States now is down more than 90 percent.
WE'RE SEEING COMMODITY PRICES DROP.
We’re seeing commodity prices drop. Gasoline prices are down more than 30 percent from the peak. Oil prices are down 34 percent from the peak. Broad commodity prices, including agricultural commodities, have dipped about 18 percent, which will help ease inflation.
“The price for a shipping container from China is down more than 90 percent.”
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What are your thoughts on recession?
IT WON'T BE DEEP.
It will probably be two or three quarters long, but it won’t be deep. It’s an ordered recession, artificially driven by the tightening of US and global monetary policy.
We expect to lose around 1.0 million net jobs in 2023, but nothing like what we saw at the beginning of the pandemic when over 20 million people lost their jobs, or even the Great Recession in 2008 and 2009, when we lost about 9 million positions. In the grand scope of things, it’s expected to be a very mild downturn.
CORPORATE PROFITS ARE HIGH.
If you look at corporate balance sheets, profitability remains high, which will help mitigate the depth. We’re penciling in a drop in real gross domestic product of only about a half a percent. In a normal recession, you see around a 2 percent decline in GDP.
Will the Fed keep raising rates, and what will that mean for businesses?
FINANCING COSTS WILL CONTINUE RISING.
The cost of financing will continue rising for consumers and corporations as the Fed continues raising rates. It’s vital that any company refrain from oversubscribing to new debt, and continue servicing current debt, especially with variable rate facilities.
LABOR COSTS KEEP RISING.
Meanwhile, we’re still seeing rising labor costs. That’s actually a positive also for the overall economy as we go into this downturn—earning power staying strong—but at the same time, labor costs will likely remain high, raising the cost of doing business for all types of businesses in 2023.
CONTROLLING COSTS WILL BE IMPORTANT.
Right-sizing your labor force is going to be important—that’s what we’re already seeing with layoffs in the tech sector. And you can’t always pass those costs on to customers right now. Your clients can’t handle much more. Executives will need to control costs more carefully in 2023.
Any chance the Fed could raise its 2% inflation target as some are suggesting?
THE FED CAN'T RISK ITS CREDIBILITY.
The short answer is “no.” If they do that, then the stock market jumps, and it gets a lot harder for them to bring inflation down. They also risk their own credibility if they reverse themselves. They have already lost a lot of credibility by missing how persistent the current inflationary environment has been.
EXPECT RATE CUTS IN 2024.
But I also don’t think they’re going to wait until inflation gets down to 2 percent before they start to ease off on hikes. Inflation probably won’t rise more than 3 percent by the end of this year. Once inflation settles down, we’re forecasting four quarter-point rate cuts in 2024.
“There may be some mis-pricing of risk right now as markets think the Fed will back off rate hikes.”
Monetary policy works with a considerable lag, so everything put in motion over the past few months—rising interest rates, new labor contracts, retail pricing, supply chain costs—still needs time to take effect. So we really haven’t digested the impact yet of what the Fed has done.
What risks worry you?
MIS-PRICING OF RISK.
There may be some mis-pricing of risk right now as markets think the Fed will back off rate hikes and begin cutting them in the second half of this year. There could be a sharp decline still in stock prices —price-to-earnings ratios are still very expensive, by historical standards, so there’s more downside risk there.
COLLATERAL DAMAGE IN THE DEBT MARKET.
Also, the Fed has worries about the high levels of corporate and government debt as a share of GDP. We’re seeing that globally, in China and other places. That’s something that could amplify economic and financial issues as we try to dig ourselves out of the downturn. There could be collateral damage in the debt market that isn’t yet being fully priced in the market.
BUT, CREDIT CHANNELS ARE SOUND.
Everyone has flashbacks to the Great Recession in 2008 and 2009 – the housing bubble and risky lending that drove that collapse. We don’t see anything like that this time around. Mortgage underwriting has improved, and the banks are much better capitalized.
Credit channels should continue to function normally, and that will help limit some of the downside risk to the economy and the markets.