How Economic Forecasters Got 2023 So Wrong

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
August 1, 2023

IN THIS ISSUE:

1. Wall Street Forecasters Get 2023 Totally Wrong

2. Consumer Confidence Jumps To A Two-Year High

3. U.S. Consumer Spending Fell Sharply in the 2Q

4. Deutsche Bank Says Recession May Be Avoided

Overview: Wall Street Forecasters Get 2023 Totally Wrong

Let me say at the onset that economic and market forecasters don’t have the greatest track record to begin with. It is not unusual to see their forecasts out of step with what actually happens in the real world. But there’s usually also a contingent that gets it right.

Not this time, apparently. Virtually all the well-known forecasters predicted a recession in 2023. I read a lot of forecasts and not one I saw predicted the economy would grow above 2% in the first half of 2023 as it has, and virtually every one forecast a recession in the second half of this year, with many signaling a serious contraction.

I don’t remember a time when such a broad swath of forecasters were this bearish. I’ve been writing about it all year, while also making it clear that I didn’t share these overly negative views. Regular readers know I have consistently maintained that a recession is not the most likely scenario for this year.

Could it happen? Sure – there’s always a chance consumers can get spooked and pull back on their spending – which accounts for almost 70% of GDP. But is this the most likely scenario? I have said all year I believe the answer is NO.

So, the question is, how did forecasters get it so wrong this time around? I think I can explain it.

Let's start by looking back to 2022. The economy (GDP) grew by 2.1% in 2022. But as the year wore on, forecasters came to be more and more pessimistic in their outlooks for 2023. There were several reasons for this. Early on, there were concerns about soaring food and energy prices.

You’ll recall the Consumer Price Index spiked to 9.1% in June of last year. It was the highest level in over 40 years. Most forecasters concluded this was a very bad omen for 2023. The Fed began raising interest rates aggressively.

Chart showing drop in consumer price index

Fortunately, inflation began to ease steadily and as of June of this year, the CPI stood at 3% year-over-year. Of course, forecasters had no way of knowing inflation would come down this far and fast.

Next, there is the inverted yield curve where short-term rates are higher than longer-term rates. The US yield curve inverted last year and has gotten worse this year. Most forecasters agree that an inverted yield curve most often leads to a recession, but the economy has proven to be resilient to this point. Still, this is another concern for forecasters.

Next, there was the decline in home prices. US home prices peaked in June 2022 and declined until January 2023 and then began to recover. The decline was modest at only about 0.2% and does not suggest something considerably worse lies just ahead.

Home sales are a different story. For the 12 months ended June, US home sales fell 18.9%, which is of course a big number. However, home experts agree that the sharp decline is largely the result of a limited supply of homes on the market, and not due primarily to decreased buyer demand. Despite that, many forecasters expressed concerns.

For these reasons and others, most forecasters issued negative outlooks for 2023. As noted earlier, forecasters are reluctant to change their predictions, even when they look to be in question. It remains to be seen what will happen this time as it looks increasingly likely there will NOT be a recession later this year.

U.S. Consumer Confidence Jumps To A Two-Year High

US consumer confidence shot to the highest level in two years this month as inflationary pressures eased and the American economy continued to show resilience in the face of significantly higher interest rates.

The Conference Board, a business research group, said its Consumer Confidence Index rose to 117 in July from a revised 110.1 in June. The gauge beat the 110.5 that economists had expected and was the highest since July 2021.

Chart showing unexpected rise in consumer confidence index

The index measures both Americans’ assessment of current economic conditions and their outlook for the next six months. Both improved in July. The future expectations index rose to 88.3 in July, up from 80 recorded in June.

Economists closely monitor Americans’ spirits because consumer spending accounts for around 70% of US economic activity. The Conference Board index fell more or less steadily from mid-2021 to mid-2022 as surging prices ate into household budgets.

But confidence has come back, in fits and starts, over the past year as inflation eased in the face of 11 interest-rate hikes by the Federal Reserve. Fed policymakers raised their benchmark rate again Wednesday to the highest level in 22 years.

The US economy – the world’s largest – has proved surprisingly resilient in the face of sharply higher borrowing costs. Employers are adding a strong 278,000 jobs a month so far this year; and at 3.6% in June, the unemployment rate is near a half-century low.

Tumbling inflation and sturdy hiring have raised hopes the Fed just might pull off a so-called “soft landing” – slowing the economy just enough to tame inflation without tipping the United States into recession.

“Expectations for the next six months improved materially, reflecting greater confidence about future business conditions and job availability,” said Dana Peterson, the Conference Board’s chief economist. “This likely reveals consumers’ belief that labor market conditions will remain favorable.”

U.S. Consumer Spending Fell Sharply in the 2Q

Despite consumer confidence hitting a two-year high in July, consumer spending took a hit in the 2Q. Consumer spending, which accounts for over two-thirds of economic output, grew at just a 1.6% rate in the second quarter, down sharply from a 4.2% rate in the first three months of the year.

This was driven by a sharp pullback in spending on durable goods, which are products such as cars, washing machines and other big-ticket items meant to last at least three years.

The slowdown in consumer spending reflects cooling demand, which the Federal Reserve has been trying to achieve through a series of aggressive interest rate increases. After hiking its benchmark lending rate by a quarter point this week, the Fed will likely view the GDP report in a positive light.

Even though spending cooled from the robust pace earlier in the year, it hasn’t fallen off a cliff – thanks to employers still hiring and real wage growth finally picking up.

Employers added 209,000 jobs in June, a weaker gain than in the prior month, but still robust by historical standards. Americans’ paychecks are also finally beating inflation, with US workers’ real weekly earnings growing in June for the first time in 26 months.

“In terms of what’s driving consumers’ ability to spend, rather than relying on stimulus and stocked-up savings or cash that they accumulated throughout the pandemic, now that tight labor market is translating into real income gains as inflation slows, which I think is an important tailwind for spending,” Shannon Seery, an economist at Wells Fargo’s Corporate and Investment Bank, told CNN.

Seery said consumers have also “shifted their spending patterns in terms of their actual consumption,” which was reflected in consumers cutting back on durable goods purchases in the second quarter, specifically cars, parts, etc. Economists say the shift in spending toward services from goods is still underway.

The fate of spending largely hinges on the state of the labor market. So, if employers continue to churn out jobs, and wages continue to grow as inflation slows, then consumers will still have healthy purchasing power.

It remains to be seen whether the Fed can successfully defeat inflation without seeing a deterioration in the labor market – but so far, both spending and hiring have abated slightly and gradually.

Deutsche Bank Now Says Recession May Be Avoided

Deutsche Bank, one of the many forecasters calling for a recession later this year, just altered its economic outlook and now says a “soft landing” may be possible in the US later this year. A soft landing simply means the economy will continue to slow down but a recession will be avoided.

While still not ruling out a recession, Deutsche Bank now says the odds of avoiding a full-on contraction have increased. The bank infers this is due to the fact that inflation has come down quicker than expected, and this should allow the Fed to raise interest rates less than had been previously anticipated.

“In brief, we see the line between mild recession and soft landing as increasingly fine and view the probabilities of the latter outcome undeniably on the rise.”

If the economy continues to grow even mildly as I expect over the next few months, I believe we’ll see more and more forecasters revising their predictions of a recession in the second half of this year.

In any event, it increasingly looks like the forecasting crowd was way too bearish on the US economy for 2023. Regular readers know I have felt this way all along and did not believe a recession was the most likely scenario.

I’ll leave it there for today.

Best personal regards,

Gary D. Halbert

SPECIAL ARTICLES

Consumer Confidence Hits 2-Year High, Recession Fears Linger

Economy Stronger Than Expected, But Consumers Pulling Back

Deutsche Bank: U.S. Recession Or Soft Landing?

Gary's Between the Lines column:
Forecasters Softening Views On Recession In 2023