By Dr. Christopher Kuehl and Mr. Keith Prather

There are many questions about 2023 and the direction of the national economy. The most pressing surround the potential for a recession and the path of inflation. There is fodder for both the “glass half empty” as well as for the “glass half full” position. Much of the variability revolves around the pace of interest rate hikes.

Potential Rate Hikes?

If the Federal Reserve still thinks the greater threat is coming from inflation, rate hikes will keep coming. Roughly 60% of US households are now living paycheck-to-paycheck (up from 51% a year ago). With this razor thin margin of household flexibility, taming inflation is critical in ensuring that these households have a better chance of remaining solvent.

If there is a sense that inflation has reached its peak, the Federal Reserve’s emphasis will shift toward limiting recession risk to the economy. In the past several decades, the Fed’s pattern has been to slow down or pause rate hikes when they see signs that the economy is cooling. The problem is that cooling starts about seven to nine months after a rate hike cycle and typically by the time slowing occurs, it takes time to reverse economic deceleration. The challenge is whether there is evidence that a breaking point has been reached and then to get as far ahead of it as possible to slow rate hikes before a deeper recession starts.

Evidence of Easing Global Inflation

There is some evidence that global inflation rates may have peaked or are close to that point. The first factor is factory gate prices have been falling for the last few months – as measured by the Producer Price Index. It was up another 0.3% month-over-month in November and is 7.4% higher than what it was this time last year. The growth has been more noticeable in the services sectors than in goods producing industries, but there has been a positive cooling of inflation across both categories.

The second positive trend has been seen in the cost of shipping. Container rates are 40% below what they were just a few months ago and a constrained capacity issue in trucking has eased from the start of the year when there were 14 loads for every available truck. That rate is now down to about four loads per truck. The norm has been historically closer to two loads per truck. The rail strike was averted and that took pressure off as well.

The third positive sign has been a decline in commodity pricing. This has not been universal, but as an example, the per barrel price for oil has fallen to $71 for West Texas Intermediate (WTI) and $76 for Brent Crude (in early December). This has also pushed down the price for gasoline. The national price according to AAA was $3.26 a gallon, slightly lower than last year’s $3.33 per gallon average for the same period.  Across the Midwest, prices for gasoline were 10 cents higher year-over-year according to the EIA.

Lumber prices are down based on reduced demand and there have been some reductions in metal commodity prices (although steel has been staying stubbornly elevated). Many commodities used in construction continue to face difficult supply chain challenges, and some materials like PVC prices for plumbing remain elevated because of continued resin shortages. Some reductions in global demand will start to help soften those shortages, and prices will ease as well.

The fourth shift has been seen within consumer expectations. The fact that consumers are slightly less worried about inflation in 2023 has helped slow down price hikes. When consumers expect higher prices in the future, they tend to make purchases sooner rather than later and that additional demand helps drive prices higher. The reduction in gasoline prices (as mentioned) has apparently convinced the consumer that next year may not be all that bad. All of this combines to suggest that inflation may be fading as a motivator of consumer behavior, pushing prices lower as retailers and wholesalers discount prices to increase sales.

Are We Headed for Recession?

One of the top challenges is for the Federal Reserve to determine the timing for easing Federal interest rate hikes. Usually, the Federal Reserve would be watching the job market closely to know when to start a pause (stopping rate hikes) or a pivot (reducing rates). The Fed is forecasting that the unemployment rate will have to hit 4.5% to slow down wage inflation, a type of inflation that is typically “sticky” because it takes some time to cool down. The current unemployment rate is still at 3.7% and that would seem to give the Fed more room to hike rates.

There are several factors that have made using the jobless numbers more complicated. The layoffs that might have been expected have not happened because many of the manufacturers are reluctant to lose talent that they have had to struggle so hard to find and retain in the past few years. The labor shortage issue has been acute and that affects decisions about hiring and firing. There are also many millions of workers engaged in the “gig economy” of Uber, Lyft, Doordash and dozens of other variations. Those workers are hard to count as part of the workforce.

The Fed appears to be looking at other indications of a slowdown – such as the sharp reduction in the housing sector. It can be successfully argued that single family housing is already in a recession with permits down by over 10%. However, the multi-family sector is booming with permits up by over 11% and the total number of permits being issued is as high as they have been since the 1980s.

What does all this mean from the standpoint of a recession in 2023? If there is a consensus view emerging it is that there will be a recession in the first couple of quarters. The downturn may likely be shallow and possibly followed by recovery in the third and fourth quarters (growth between 2.5% and 3.0% in the second half of the year).

Midwest: Positioned for Growth

For the Midwest the rebound will be quicker if certain factors play out. Top among these is the potential for extensive reshoring activity. It is obvious that supply chains are in flux and reshoring (moving sourcing and manufacturing back into the United States) has already taken place in the US, including roughly $115 billion in construction spending in the manufacturing sector so far this year. The expectation is that there will be a trillion dollars invested in reshoring over the next seven to ten years.

Companies that are moving out of China are also investing in other overseas platforms such as Vietnam, Thailand, Mexico, and Africa. Many have elected to return to the US as well given that they can rely on technology and robotics to be competitive with the low-labor-cost platforms in the rest of the world. There are many compelling arguments for the reshoring of production but there are challenges as well. This is where some of the advantages of the Midwest come in.

The three limiting factors for reshoring include 1) availability of labor, 2) availability of transportation and 3) availability of materials and energy. The Midwest is not sitting on an abundance of labor (the average rate of unemployment is about 3%) but there are people with needed skills and there is perception of a strong midwestern work ethic.

The transportation and distribution advantages are clear considering the centrality and extensive hub of connected highway systems in the region as well as expected rail sector improvements. Even barge traffic creates opportunities in the region and inland ports are speeding up the processing of inbound freight (especially component parts and raw materials used in manufacturing in the Midwest).

Of critical importance is the availability of energy – both traditional fossil fuel as well as alternatives such as wind and solar power. With fewer regulatory issues in the Midwest and ample access to various forms of energy, the advantages will become more defined in the coming years.

The upshot is that many communities in the middle of the country will see intrigue from manufacturers and others interested in diversifying their supply chains and reducing the dependence on foreign sourcing.

Over the years there have been observations regarding how the middle of the country reacts to economic waves. The region never quite feels big surges of growth to the degree often experienced in the southwest and southeast. This has been especially true in cities such as Kansas City, Oklahoma City, Tulsa, Wichita, Omaha, Des Moines, and Minneapolis. The plus is that these communities also rarely experience the lows that other regions experience. The expectation is that growth nationally will be close to zero (or even in negative territory) in the first two quarters of 2023 but the estimate in the Midwest is for growth of perhaps .5% and improving steadily for the rest of the year. If there is an overall assessment of what lies ahead in 2023 it is one of cautious optimism weighted towards the latter part of the year. The first two quarters will be rough for most, but from that point the advantages supplied by the middle of the nation start to manifest.

About the Authors

Dr. Christopher Kuehl and Keith Prather are founders and managing directors of Armada Corporate Intelligence. Dr. Kuehl holds a Ph.D in Political Economics and Masters Degrees in Soviet Studies and East Asian Studies. He works with a wide variety of corporate clients around the world and is the economist for several national and international organizations. Mr. Keith Prather has been providing corporations with market intelligence and analysis covering domestic and global economics, geopolitics, raw material and supply chain developments, environmental impacts and other factors that affect the corporate operating environment for more than 22 years.

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