Why It’s About to Get Even More Complicated From Here
This year’s choices were hardly simple, but economic policymakers in China, Europe and the United States face much trickier decisions in 2023.
If making economic policy seems complicated this year, it’s about to get much harder.
The good news is that the extreme outcomes investors worried about through most of 2022 look less likely for 2023. Central bank tightening seems to be working. As supply chains normalize and demand cools, inflation is heading lower.
Conversely, the dire predictions of a global economic collapse have yet to play out. If anything, the odds of a serious recession seem to be moderating given the recent strength of labor markets, corporate profits and bank balance sheets.
But there’s still plenty of uncertainty about an outlook that is neither boom nor bust. Three complicated sets of policy decisions loom in the coming months.
In China, the pace of relaxing COVID restrictions will determine just how strong a recovery to expect in the world’s second largest economy. In many ways, imposing strict lockdowns looks like an easy choice compared to the much more uncertain process ahead. Local officials will have to decide which restrictions they can remove to restore more normal levels of activity even as they assess the risks of rising infections overwhelming the healthcare system.
With a property market only now stabilized, consumer confidence may be slow to bounce back. But even a halting rebound counts as a recovery. Indeed, as long as officials calibrate a post-pandemic strategy more or less successfully, China will be the only major economy where growth will actually accelerate next year even if it falls short of current 5% forecasts.
Europe’s most important decisions center around its energy needs as it ends oil and gas purchases from Russia. Again, this year’s scramble to secure alternative sources of supply was hardly simple and may still fall short if the weather turns much colder. But the task ahead is to secure next winter’s supply at a reasonable price, while minimizing the shock to a much weaker economy.
Global prices remain beyond the control of European finance officials, but they will be hunting for new liquefied natural gas supplies just as China’s demand for energy recovers, too. They will also need to decide how best to cushion the pain from higher energy prices with extended subsidy schemes.
The outlook is not nearly as dire as it was just a few months ago when there was talk of energy rationing and rolling blackouts. But the European Central Bank will face difficult choices as it tries to weigh inflation risks that hinge largely on highly volatile energy prices.
In the United States, all eyes will remain on the Federal Reserve as it navigates what even Chair Jerome Powell admits is a narrow path to a soft landing. Abandoning “Team Transitory” and hiking rates sharply this year now looks obvious with consumer price inflation that peaked in June at 9.15%. The difficult judgements ahead will rest on cooling a hot jobs market without inflicting too much damage on the rest of the economy.
Recent data show that labor demand has started to ease as both job openings and quit rates fall. But historically low unemployment levels and rising hourly earnings remain worries and may force tighter policy for longer.
On the other hand, existing home sales are falling fast after the recent spike in mortgage rates. Prices remain far above pre-COVID levels and need to settle in more affordable ranges, but there are worries that a rapid deterioration could undermine consumer demand and make the recession much more serious.
High prices and interest rates globally should continue to cool demand and bring inflationary pressures back under control. But just how long and messy that becomes will depend largely on COVID choices in China, energy decisions in Europe and interest rate balance in the United States. For now, a European recession looks likely, while the U.S. downturn should be mild and relatively brief.
Markets may deliver more volatility under these circumstances rather than a large move in either direction. These delicate choices will likely deliver mixed signals to markets amid a continuing stream of conflicting and contradictory data. Difficult decisions for policymakers mean difficult decisions for investors, too.