Viewpoint

December 22, 2023 | 13:59

December 22, 2023

Economist

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Our Thoughts

Stirred but not Shaken—The U.S. Defies the Odds in 2023

Well, we are finally here: time to close the books on 2023 and open a new chapter in 2024. But before we do, let’s take a quick look back at the U.S. economy’s unexpected highs and lows over the past year. First, I can’t recall a time in my long career when the U.S. economy so impressively beat the odds and surpassed expectations as much as it did over the past twelve months. Though you wouldn’t know it if you were just looking at the latest polls on the U.S. economy. At this time last year, we were all bracing for what looked like a mild and short recession in 2023. The Fed had been tightening monetary policy aggressively for almost a year, the stock market was down more than 20%, real incomes had been dropping for nearly two years as inflation hit its highest level in 40 years, pandemic savings were being rapidly depleted and real consumer spending was starting to falter under the weight. Real GDP growth (which, in 2021, was roaring at 5.4% Q4/Q4) had already slowed to a crawl of just 0.7% by the end of 2022. The Treasury yield curve and the Conference Board’s Leading Economic Index were both flashing ominous recession warning signs. The yield curve was already highly inverted, and the Fed wasn’t done hiking interest rates yet; and the Conference Board’s Leading Economic Index was dropping sharply on both a month-over-month basis and on a year-on-year basis to an extent usually only seen in the lead-up to recession.

Yes, there was still a small chance of a soft landing, but the historical track record was not very encouraging—most Fed monetary tightening cycles that aimed to stop runaway inflation ended up in recession. But then 2023 began, large social security cost-of-living increases were paid out in January and consumers swiftly returned to the stores and took to the air to reconnect with loved ones and friends and make new life experiences. Real consumer spending rebounded at a 3.8% annualized pace in the first quarter of 2023, up from an anemic 1.2% a.r. in the fourth quarter, defying the consumer confidence and other business survey data that pointed to an ongoing consumer funk.

Then the regional banking turmoil hit in the second quarter with a 1930s-style bank run on Silicon Valley and First Republic Banks—but with 21^st century technology, meaning the panic was spreading faster and wider than in the past. Bank credit and financial conditions tightened sharply before the Fed jumped in with new emergency liquidity and credit facilities to staunch the bleeding. The probability of a U.S. recession over the next twelve months soared to over 70%, and it looked like this could be the shock that would finally trigger the economic downturn we had all been anticipating. But then bank liquidity rebounded thanks to the Fed’s supports; financial and credit markets quickly normalized; and it was as if the crisis never happened. The dreaded bank credit crunch never fully materialized; and, after a couple of months' pause in consumer spending in the second quarter, consumer spending growth returned robustly in the third quarter.

But a resilient consumer wasn’t the whole story of 2023. Business investment also held up better than expected, as the Inflation Reduction Act and Chips Act spending, subsidies, and tax incentives kicked in. This is seen in the structures component of business investment that jumped at a 30.3% annualized pace in the first quarter and has averaged a huge 19.2% annual pace over the last three quarters, as businesses rush to take advantage of the government incentives. All this structural investment is happening even as a glut of vacant post-pandemic office space continues to plague the country.

Pure government spending itself was another important support this year. Real spending at the state and local levels averaged a robust 4.8% in the first three quarters of 2023, while federal spending clocked in at a whopping 4.5% pace.

In short, 2023 was a wild rollercoaster ride, both economically and financially. But in the end, strong real spending growth kept labor market conditions relatively tight compared to forecasts. The U.S unemployment rate, at 3.7% in November, is just two tenths of a percentage point higher than where it ended 2022, and nonfarm payrolls are expected to grow by around 2.8 million jobs this year Q4/Q4. In 2019, the last year before the pandemic, the U.S. economy only created 1.9 million jobs Q4/Q4—a third less than this year. Even so, restrictive monetary policy and easing supply constraints over the last two years have brought consumer inflation down faster this year than many expected, even at the Fed. CPI inflation slowed from an average 7.1% in Q4 2022 to around 3.1% year-on-year today. If inflation continues to moderate as we expect in 2024, this will keep real disposable incomes rising and consumers spending even as we expect less support from government and business investment spending in the first half of 2024.

My point of this walk down memory lane as we celebrate the holidays, and some economists once again double down on their 2023 recession calls for 2024: beware the perma-bears. There is the equally large danger of underestimating the U.S. economy’s performance yet again in the New Year. Happy Holidays everyone!