It looked like there would be a slowdown at the start of 2023. Not anymore, says the chief economist at Bank of America. He now thinks that growth will be strong next year and inflation will go down.
Back in January, when the Federal Reserve was just starting its bold campaign to raise interest rates to fight rising prices, Bank of America and many other Wall Street firms predicted that a recession was on the way.
But as the year has gone on, Michael Gapen, a well-known economist, has slowly become more positive about the future of the U.S. economy. And in his most recent note to clients, Gapen says the much-touted “soft landing” that was once thought to be almost impossible is now looking likely.
The Fed’s Rapid Rate Hikes Originally Pointed to Recession
Gapen’s first call for a recession was based on simple logic based on history. So that prices would drop, the Fed started raising interest rates at a rate that had never been seen before.
This was done because inflation was at its highest level in more than 40 years. And in the past, times when rates rose quickly almost always led to recessions and higher unemployment.
Eleven times before 2022, when the Fed raised rates as quickly as it did this time, the economy went into a recession. “The odds seemed heavily stacked against the economy navigating rate hikes without falling into recession,” Gapen said.
Upbeat Data Leads to Forecast Upgrades
The economy didn’t do as badly as feared, though, as 2022 went on. Even though rates tripled from almost zero to almost 4.5 percent, important areas like consumer buying and the job market did very well.
In honor of John Lennon, Gapen called his note canceling the call “Imagine No Recession” in August, which meant that Gapen no longer thought about recession at all.
Gapen now thinks that his first prediction was “too negative.” Not only does he not see a slowdown in 2024, but he also sees faster growth and lower inflation than he did before. He wrote on Monday, “The Fed seems closer than ever to’sticking the landing.'”
What Changed: Consumers Keep Spending as Rates Rise
What’s really making Gapen and Bank of America so happy? The ability of American consumers to keep spending at a good rate even though it costs more to borrow money.
In November, retail sales were up 4.1% year-over-year. Sales on Black Friday and Cyber Monday were even better than expected.
And even though measures of consumer trust are still low, what consumers actually do says a different story. Gapen says that higher family net worth and a still-strong job market have made spending surprisingly stable.
The median American household’s net worth rose 37% from 2019 to 2022, reaching almost $193,000, according to statistics from the Federal Reserve.
Gapen thinks people will keep shopping as long as they feel safe with their money. As of now, inflation seems to have peaked and is slowly going down from over 9 percent to around 3 percent. This could help customer budgets in 2023.
2024 Outlook Now Includes Faster Growth and Lower Inflation
Gapen raised Bank of America’s 2024 forecast by a large amount because the economy has been stronger than expected so far:
- GDP growth of 1.2%, up 0.6 percentage points
- Unemployment rate of 4.2%, down from 4.4%
- Inflation as measured by PCE at 2.2%, 0.2 percentage points lower
Gapen now thinks that next year will see slow but steady growth instead of a slump. And most importantly, inflation going down from where it is now without a big rise in unemployment.
“Incoming data is signaling the U.S. economy can enjoy both modest growth and disinflation simultaneously,” Gapen said. That mix of strong growth and falling prices is what makes a “soft landing” possible, and it’s looking more and more likely to happen.
Structural Changes Have Made the U.S. Economy More Resilient
What has changed in the last few years that Gapen thinks has made the economy stronger? He points out three important changes:
Improved Lending Standards – Stricter requirements for mortgages and other loans mean fewer Americans are financially overextended. Variable rate mortgages are far less common. So rate hikes don’t hit household budgets as severely.
Pandemic Inflation Drivers Fading – Much of the inflationary surge stemmed from COVID-19 supply chain dysfunction and energy/food price volatility. As pandemic effects recede, those drivers of inflation naturally fade too.
Strong Labor Market Protects Spending – With unemployment still near 50-year lows at 3.7% and over 1 million more job openings than unemployed Americans, incomes have held up well. And financially secure households keep spending.
Gapen thinks that the U.S. economy is becoming more fundamentally stable, meaning that it can handle rising interest rates without falling into a recession. Soft landings, which doubters used to say were not possible, now look like they will happen in 2023.