Trust the Models? In This Economy?
Historical data has always been critical to those who make economic predictions. But three years into the pandemic, America is suffering through an economic whiplash of sorts — and the past is proving anything but a reliable guide.
Forecasts have been upended repeatedly. The economy’s rebound from the hit it incurred at the onset of the coronavirus was faster and stronger than expected. Shortages of goods then collided with strong demand to fuel a burst in inflation, one that has been both more extreme and more stubborn than anticipated.
Now, after a year in which the Federal Reserve raised interest rates at the fastest pace since the 1980s to slow growth and bring those rapid price increases back under control, central bankers, Wall Street economists and Biden administration officials are all trying to guess what might lie ahead for the economy in 2023. Will the Fed’s policies spur a recession? Or will the economy gently cool down, taming high inflation in the process?
With typical patterns still out of whack across big parts of the economy — including housing, cars and the labor market — the answer is far from certain, and past experience is almost sure to serve as a poor map.
“I don’t think anyone knows whether we’re going to have a recession or not, and if we do, whether it’s going to be a deep one or not,” Jerome H. Powell, the Fed chair, said during a news conference last week. “It’s not knowable.”
Doubt about what comes next is one reason the Fed is reorienting its monetary policy approach. Officials are now nudging borrowing costs up more gradually, giving them time to see how their policies are affecting the economy and how much more is needed to ensure that inflation returns to a slow and steady pace.
As policymakers try to guess what lies ahead, the markets that have been most disrupted in recent years illustrate how big changes — some spurred by the pandemic, others tied to demographic shifts — continue to ricochet through the economy and make forecasting an exercise in uncertainty.
Housing is strange.
The pandemic era has repeatedly upended the housing market. The virus’s onset sent urbanites rushing for more space in suburban and small-city homes, a trend that was reinforced by rock-bottom mortgage rates.
Then, reopenings from lockdown pulled people back toward cities. That helped push up rents in major metropolitan areas — which make up a big chunk of inflation — and, paired with the Fed’s rate increases, it has helped to sharply slow home buying in many markets.
The question is what happens next. When it comes to the rental market, new lease data from Zillow and Apartment List suggests that conditions are cooling. The supply of available apartments and homes is also expected to climb in 2023 as long-awaited new residential buildings are finished.
The Biden Presidency
Here’s where the president stands after the midterm elections.
- A New Primary Calendar: President Biden’s push to reorder the early presidential nominating states is likely to reward candidates who connect with the party’s most loyal voters.
- A Defining Issue: The shape of Russia’s war in Ukraine, and its effects on global markets, in the months and years to come could determine Mr. Biden’s political fate.
- Beating the Odds: Mr. Biden had the best midterms of any president in 20 years, but he still faces the sobering reality of a Republican-controlled House for the next two years.
- 2024 Questions: Mr. Biden feels buoyant after the better-than-expected midterms, but as he turns 80, he confronts a decision on whether to run again that has some Democrats uncomfortable.
“The frame I would put on 2023 is that we’re really going to enter the year back in a demand-constrained environment,” said Igor Popov, chief economist at Apartment List. “We’re going to see more apartments competing for fewer renters.”
Mr. Popov expects “small growth” in rents in 2023, but he said that outlook is uncertain and hinges on the state of the labor market. If unemployment soars, rents could fall. If workers do really well, rents could rise more quickly.
At the same time, existing leases are still catching up to the big run-up that has happened over the past year as tenants renew at higher rates. It is hard to guess both how much official inflation will converge with market-based rent data, and how long the trend will take to fully play out.
“It could resolve in months, or it could take a year,” said Adam Ozimek, the chief economist at the Economic Innovation Group.
Then there’s the market for owned housing, which does not count into inflation but does matter for the pace of overall economic growth. New home sales have fallen off a cliff as surging mortgage costs and the recent price run-up has put purchasing a house out of reach for many families. Even so, new mortgage applications have ticked up at the slightest sign of relief in recent months, evidence that would-be buyers are waiting on the sidelines.
Demographics explain that underlying demand. Many millennials, the roughly 26- to 41-year-olds who are America’s largest generation, were entering peak home-buying ages right around the onset of the pandemic, and many are still in the market — which could put a floor under how much home prices will moderate.
Plus, “sellers don’t have to sell,” said Mike Fratantoni, chief economist at the Mortgage Bankers Association, who expects home prices to be “flattish” next year as demand wanes but supply, which was already sharply limited after a decade of under-building following the 2007 housing crash, further pulls back.
Given all the moving parts, many analysts are either much more optimistic or very pessimistic.
“It’s almost comical to see the house price growth forecasts,” Mr. Popov said. “It’s either 3 percent growth or double-digit declines, with almost nothing in between.”
The car market remains weird, too.
The car market, a major driver of America’s initial inflation burst, is another economic puzzle. Years of too little supply have unleashed pent-up demand that is spurring unusual consumer and company behavior.
Used cars were in especially short supply early in the pandemic, but are finally more widely available. The wholesale prices that dealers pay to stock their lots have plummeted in recent months.
But car sellers are taking longer to pass those steep declines along to consumers than many economists had expected. Wholesale prices are down about 14.2 percent from a year ago, while consumer prices for used cars and trucks have declined only 3.3 percent. Many experts think that means bigger markdowns are coming, but there’s uncertainty about how soon and how steep.
The new car market is even stranger. It remains undersupplied amid a parts shortages, though that is beginning to change as supply chain issues ease and production recovers. But both dealers and auto companies have made big profits during the low-supply, high-price era, and some have floated the idea of maintaining leaner production and inventories to keep their returns high.
Jonathan Smoke, chief economist at Cox Automotive, thinks the normal laws of supply and demand will eventually reassert themselves as companies fight to retain customers. But getting back to normal will be a gradual, and perhaps halting, process.
Still, “we’re at an inflection point,” Mr. Smoke said. “I think new vehicles are going to be less and less inflationary.”
Labor markets are the most important question mark.
Perhaps the most critical economic mystery is what will happen next in America’s labor market — and that is hard to game out.
Part of the problem is that it’s not entirely clear what is happening in the labor market right now. Most signs suggest that hiring has been strong, job openings are plentiful, and wages are climbing at the fastest pace in decades. But there is a huge divergence between different data series: The Labor Department’s survey of households shows much weaker hiring growth than its survey of employers. Adding to the confusion, recent research has suggested that revisions could make today’s labor growth look much more lackluster.
“It’s a huge mystery,” said Mr. Ozimek from the Economic Innovation Group. “You have to figure out which data are wrong.”
That confusion makes guessing what comes next even more difficult. If, like most economists, one accepts that the labor market is hot right now, Fed policy is clearly poised to cool it down: The central bank has raised interest rates from near zero to about 4.4 percent this year, and expects to lift them to 5.1 percent in 2023.
Those moves are explicitly aimed at slowing down hiring and wage growth, because central bankers believe that inflation for many types of services will remain elevated if pay gains remain as strong as they are now. Dentist offices and restaurants will, in theory, try to pass climbing labor costs along to consumers to protect their profits.
But it is unclear how much the job market needs to slow to bring pay gains back to the more normal levels the Fed is looking for, and whether it can decelerate sufficiently without plunging America into a painful recession.
Companies seem to be facing major labor shortages, partly as a wave of baby boomers retires, and Fed officials hope that will make firms more inclined to hang onto their workers even if the broader economy slows drastically. Some policymakers have suggested that such “labor hoarding” could help them achieve a soft landing that bucks historical precedent: Unemployment could rise notably without spiraling higher, cooling the economy without tipping it into a painful downturn.
Typically, when the unemployment rate rises by more than 0.5 percentage points, like the Fed forecasts it will do next year, the jobless rate keeps rising. Loss of economic momentum feeds on itself, and the nation plunges into a recession. That pattern is so established it has a name: the Sahm Rule, for the economist Claudia Sahm.
Yet Ms. Sahm herself said that if the axiom were to break down, this wacky economic moment would be the time. Consumers are sitting on unusual savings piles that could help sustain middle-class spending even through some job losses, preventing a downward spiral.
“The thing that has never happened would have to happen,” she said. “But hey, things that have never happened have been happening left and right.”