The Big Idea

A midterm exam on the economy

| July 14, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Much can happen over the balance of the year, but my main economic calls for 2023 are holding up well. So far, so good. I expected the economy to outperform expectations, avoiding a recession, the labor market to remain solid, inflation to recede more slowly than generally projected, and the Fed to hike rates above 5% and leave them there well into 2024. Some of the details of the forecast have changed since late last year, but the broad narrative continues to anticipate the economy well.

Recession deferred

My first economic call for 2023 was that the economy would continue to grow, avoiding a recession until at least 2024. At the turn of the year, this was a sharply out-of-consensus call. The January Blue Chip Economic survey had median real GDP readings for the first quarter of -0.5% and for the second quarter of -0.9%. And 65% of the respondents expected a recession to begin in 2023.

My basis for optimism stemmed mainly from the fact that households were sitting on a massive cushion of excess liquidity accumulated since early in the pandemic. That theme has served me well. Real consumer spending posted a 4.2% annualized gain in the first quarter, rebounding from a sub-par fourth quarter, and is on pace to post a gain of around 1% annualized in the second quarter of this year. Such a result would yield about a 2.5% annualized advance for real consumer spending in the first half of the year, even better than 2022’s 1.7% rise.

As a result, real GDP expanded at a 2% annualized clip in the first quarter and perhaps by around 1% in the second. While this is certainly not robust growth, it is comfortably clear of recessionary territory and far above the consensus forecast from six months ago.

While many economists believe that households have burned through their excess liquidity, the Federal Reserve’s household balance sheet data indicates otherwise. In a recent piece, I ran through the calculations suggesting that, even after adjusting for inflation, households have an extra $1 trillion or so in liquid assets. I look for this cushion, along with solid income growth, to keep consumer spending, and in turn the overall economy, on a similar modestly positive track in the second half of the year—between 1% and 2% growth. In contrast, the most recent Blue Chip survey calls for roughly flat real GDP in the second half of the year.

Labor market holds up better than expected

Consistent with the consensus recession call, economists were looking for a quick collapse of the job market heading into 2023. The monthly Bloomberg survey of economists conducted in mid-January had payrolls averaging growth of only 100,000 in the first quarter and then moving into negative territory for the rest of the year, so that the economy was projected to lose jobs on balance in 2023. The unemployment rate was projected in both the Blue Chip and Bloomberg surveys to average 4.8% in the fourth quarter of 2023, a rise of over a full percentage point.

In contrast, my view entering the year was that there were significant parts of the economy that were still dealing with labor shortages and had pent-up demand for workers. I consequently called for only a gradual moderation in labor demand over the course of this year. I called for the unemployment rate to remain largely steady in the neighborhood of 3.5% for most or all of 2023.

As it turns out, job growth has begun to moderate in the first half of 2023, but it has remained robust, averaging 278,000 a month. The JOLTS job openings data offer a clear view of the labor market situation. Job openings have fallen by over 2 million from the early-2022 low to just under 10 million, signaling significant cooling. However, the latest reading remains historically robust. The all-time peak prior to the pandemic was 7.5 million. Meanwhile, the unemployment rate has been largely steady in the first half of the year, averaging 3.5% with the latest reading for June at 3.6%.

Looking ahead, I expect the pace of job gains to continue to moderate but only gradually, remaining well ahead of the pace needed to keep up with trend population growth—about 100,000 per month—for a while longer. I project the unemployment rate to remain within a tenth or two of the 3.5% mark for the balance of the year.

Inflation moderates only gradually in 2023

At the turn of the year, the consensus call for inflation, both headline and core, was for a steady deceleration, taking year-over-year advances for both below 3% by late 2023.

As with growth and employment, I projected that inflation would cool in 2023 but at a much slower pace than the consensus. I felt that shelter costs would continue to rise sharply in the first half of the year and that inflation in a number of service categories had become entrenched and would prove stubbornly high.

Notwithstanding the downside surprise in the June CPI, core inflation has been far higher than the consensus projected in the first half of the year. The core CPI ran at a 4.8% annualized rate in the first two quarters of the year, while the core PCE deflator may have risen at about a 4.5% pace.

It does appear that underlying inflation is finally beginning to moderate, but I still look for core inflation to run at close to a 4% pace over the four quarters of 2023 –4.1% for core CPI and 3.8% for core PCE. Underlying measures, such as median and trimmed-mean gauges are running well above the traditional headline and core measures, suggesting that inflation pressures remain broad-based, which likely points to a long and difficult path back to the Fed’s 2% target.

No easing in 2023

By the end of 2022, the FOMC had raised the fed funds rate target to a range of 4.25% to 4.50%. The consensus economic view called for 50 bp more tightening in the first quarter, according to the January Bloomberg survey. Fed funds futures contracts at the time had the Fed getting close to 5% by mid-year but then easing in the second half of 2023 with a year-end funds rate projection just above 4.5%.

Consistent with my economic and inflation estimates, I entered the year believing that the Fed would hike rates above 5% in the first half of 2023 and then leave them there until the summer of 2024.

Over the past six months, I have been forced to adjust my Fed call, but in the opposite direction from the prior consensus. I now expect the Fed to keep hiking into the fall, eventually reaching 5 5/8% by early November, a quarter point above the current consensus. I still believe that the first rate cut will not come until the summer of next year. In contrast, fed funds futures and SOFR futures contracts currently have the policy rate broadly steady in the second half of this year and then falling by almost 100 bp by mid-2024.

Stephen Stanley
1 (203) 428-2556

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles