Wall Street vet: Why the U.S. economy could well be headed for the hoped for “soft landing” in 2023

Editor’s note: The following commentary is the latest installment in “The Macro” — an ongoing series of posts on the state of the economy by Mecklenburg County small businessman and former Wall Street bond trader, Greg O’Connor.  

Spoiler alert right off the bat here: 2023 will not be the historically tumultuous year that 2022 was. There was so much going on economically in 2022, plus the election noise, that I would not blame anyone for feeling a bit uneasy about what is in store for 2023!

But stick with me — there are grounds for optimism.

As always, we need to take a peek back before we look forward.

The peek back begins with the over $9.5 Trillion the Fed ($5 Trillion) and Congress ($4.5 Trillion by both parties) pumped into the economy in 2020 and ‘21 to ensure America escaped the “COVID Ditch.” This “Push,” as I call it, plus another $5 Trillion from other governments around the world, plus broken supply chains, plus a war, plus changing demographics, led to those “Two Things” I wrote about in my October Macro piece: explosive economic growth, and a spike in inflation.

It is important to remember that while the shocking price increases in the first half of 2022 got most of the headlines, we also saw unprecedented economic growth. The economy added 4.5 million new jobs last year, is holding at record low unemployment, grew nominally at 9%, and saw a 5% increase in wages.

As we look to 2023, it is important to understand that “The Push,” that tidal wave of liquidity, is still pushing the American economy forward. It is there in the form of higher savings, increased home equity, and higher wages across the country. Because of this, America is easily outperforming its global peers economically.

The legislative accomplishments of the last two years: The Infrastructure Investment and Jobs Act, The American Recovery Act, The US Chips Act, and The Inflation Reduction Act, all will play a role in keeping “The Push” in place.

The Push, however, is up against a Federal Reserve that is in the process of reversing 13 years of easy financial conditions. In taking short term rates to slightly above 5%, the Fed is trying to rein in inflation in all sectors of the economy and slow down the American jobs machine. The economy has held up surprisingly well given the aggressiveness of the Fed to this point.

What to expect in 2023:

1. The strong labor market continues. The economy enters 2023 with a strong and tight labor market nationally, with 1.7 jobs available to every applicant. Monthly job gains will slow from the 400,000/month rate we saw in 2022, into the 150,000-200,000/month range, still historically strong. Expect a strong labor market in the first half of the year, with slowing in the second half of the year.
2. Good inflation news. Inflation will continue to gradually recede. Global inflationary inputs such as oil, gas, commodities, economic struggles in China, and supply chain issues are all trending lower. Expect this to continue.
3. Wage gains to remain strong. Upward pressure in wages in the U.S. will moderate only slightly from the current 4.5-5% range, in spite of Fed rate hikes. The lower end wage earners in America are gaining leverage for the first time in 40 years and the demographics of worker shortages in virtually all sectors of the economy are working in their favor as well.
4. A legislative tail wind. Past legislative actions, and the huge sums of money that come with them, will provide strong support for the economy, cushioning the effects of higher short term rates.

Fed rate hikes to slow growth only gradually 

The Fed should take short rates to the 5.25% area and hold there for most of the year, only up slightly from current levels. This is “Priced In” (expected by the markets), so while the rate should slow growth and tame employment gains over time, there will be no sudden impact or contraction due to Fed policy.

Conclusion: The dream of a soft landing could become reality!

The term “Soft Landing” in economic parlance refers to an economy that is slowing from a pace of rapid growth, but not slowing so fast that it “crashes” and contracts sharply.

Something else to know about soft landings is that they are rare and historically extremely difficult to pull off. This time however, it just might happen.

The 2022 theme of The Push vs. The Fed will continue in 2023. What gives the ability of the economy to land softly, howver, are those first four supporting factors listed above. There is great balance in this equation in my opinion.

The American economy begins the year in a good position, with abundant job opportunities and falling inflation. Wages for those on the lower end of the pay scale should continue to outpace inflation. “The Push” will continue to soften the effects of the higher short term rates engineered by the Fed, leading to the gradual slowing of economic activity as the year progresses. Soft is Good!

Greg O’Connor is a small business owner who spent 24 years trading bonds on Wall Street. He is the founder of REAL ECONOMICS on Youtube and lives in Mecklenburg County.