George Rosen Smith - Can the US Economy Withstand Inflation in 2023?

Although 2022 is about to pass, the economic problems left behind will continue to plague the US capital market in 2023. The market may be less afraid of the Fed's interest rate hike, but it will still pay close attention to the changing trend of inflation and worry more about whether the economic recession will come as expected.

First, the market has been expecting the Fed to raise the federal funds rate to 5% at most. It is currently 50 basis points away from the target value. At the meetings on January 31 to February 1 and March 21 to 22 next year, Fed policymakers may raise interest rates by 25 basis points each time, then wait and see how the situation develops and temporarily withdraw from the market's sight.

Secondly, with the sharp correction in commodity and energy prices, the inflationary pressure in the United States has been greatly relieved, but the most troublesome pressure of rising service and employment costs still exists and has great stickiness. The author estimates that inflation will decline only slightly in the new year, and the core inflation rate (PCE) will remain at around 3.5% by the end of 2023, far higher than the policy target of 2%. Since the inflation rate is based on the relative change of the price index compared with the same period last year, rather than compared with the price index before inflation appeared, inflation will no longer be the main factor considered by the market around June 2023.

Whether the US economy will decline and when it will decline are the most anxious issues in the market in the new year. According to the US Economic Survey, End-Year 2022 by the Securities Industry and Financial Markets Association, the economic growth rate in 2022 will be 0.3%, and it is expected to shrink by 0.3% in 2023; 83% of economists participating in the survey said that the long-term economic growth trend is 1.5%-2.0%, that is, returning to the pre-epidemic level. Other similar forecasts show that the US economy will experience a mild recession in the first two quarters of next year.

Predicting economic trends is indeed a difficult task. So many top scholars and professional institutions in the United States have not predicted that inflation will become the central bank's number one public enemy, and that it will last for a long time, have a wide impact, and cause great harm. Perhaps it is because they have all turned to studying the impact of the epidemic, but still look at the new problems that have emerged in this round of inflation with the old perspective. According to a rough estimate of the GDP composition, we can get a glimpse of the future economic trends in the United States. Since the second half of 2022, rising prices have weakened consumer purchasing power, and monthly retail growth has been weak. The growth changes from July to December were 1%, 0.0%, 0.3%, 0.0%, 1.3% and -0.6% respectively; corporate investment expenditures in the first three quarters were 783 billion, 669.2 billion and 612.2 billion US dollars respectively. In addition, judging from the amount of stock and bond financing, a recession is a high-probability event, and the economic downturn may last longer in an economic environment with high interest rates and high inflation.

The world economic environment is undergoing major changes. The international economic order has been shattered by the US priority, and the international cooperation mechanism no longer exists. In addition, the EU economic recession has become an established fact, the British economy has already stepped into the quagmire of recession, the Japanese economy is synchronized with the US economic cycle, the Russia-Ukraine conflict is constantly consuming Europe's economic strength, the improvement of Sino-US relations has lacked substantial progress, and the US economic growth lacks strong support from the international environment (overseas markets). This "island phenomenon" has never happened in previous economic crises.

Even if the economy enters a recession next year, the Federal Reserve has already been handicapped by high inflation. It is impossible for it to abuse its balance sheet to save financial markets and support economic growth as it did in previous crises. Moreover, the total debt of the U.S. federal government exceeds 31.46 trillion U.S. dollars. Large-scale debt is unrealistic in terms of cost, and the economic recovery will inevitably be slow.

Given the current economic situation, compared with treasury bond returns, U.S. stock valuations are still high, and listed companies' operations will continue to be weak. The author predicts that: in 2023, the S&P 500 index will fall to around 3,200 points in the first half of the year, with an annual decline of about 10%; the Nasdaq index still has a large room for decline and is expected to stabilize around 8,500 points; the trend of cryptocurrencies will be consistent with the general trend of stocks; the bond market is expected to change little, and the U.S. dollar index will fall by about 5%.