Confused about the 2023 economic outlook for the US, the world’s largest economy? You are far from the only one. Over the past six months, the consensus narrative among economists and Wall Street analysts has gone from an expected soft landing, to a hard landing, to no landing. Most recently, the consensus has appeared to move back to a hard landing, with some even worrying about a banking turmoil-induced crash.
This rollercoaster mainly reflects the interaction of external developments with policy slippages and inconsistent policy communication from the Federal Reserve. It is one that is unusual for what is the world’s most influential economy, with mature institutions.
And it is not just market narratives that have seen volatility. Moves in key segments of financial markets have also been akin to a rollercoaster ride. Consider, for example, the yield on the two-year Treasury bond, which plays a significant role in many financial activities. Normally anchored by Fed policies and its forward guidance, this yield fluctuated in March in the eye-poppingly wide range of 3.58 to 5.08 per cent.
Meanwhile, markets have continued to dismiss the path for 2023 rates signalled by the Fed, pricing in a series of interest-rate cuts that chair Jay Powell and his colleagues repeatedly asserted would not happen. These unusual developments are unlikely to dissipate any time soon given the cyclical and structural uncertainties facing the US economy.
Moreover, the Fed is unable to act as a strong enough anchor given its lack of a clear strategic vision and an outdated monetary policy framework. No wonder several veteran economists have acknowledged that this is one of the most uncertain times for the US economy that they have experienced in their careers.
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The right response to such unusual uncertainty is to embrace it and adapt. And as complicated as the outlook is, it is possible to specify a set of issues that is likely to determine the eventual economic outcomes.
First, there is the less elastic supply side of the economy as the world navigates the energy transition, labour market tightness, corporate rewiring of supply chains and the manner in which geopolitical tensions are changing globalisation.
Second is the Fed’s ability to reduce inflation while containing the damage to jobs and growth and maintaining financial stability — the policy trilemma.
Third is the extent of adverse economic contagion arising from the recent tremors in community and regional banks, including First Republic’s fragility and the overall impact on bank lending of higher funding costs, greater loan loss provisions, a less stable deposit base and the likely onset of tighter supervision and regulation.
And fourth is the ever more complicated relationship between economics and politics, both domestically (including the US debt ceiling) and internationally (including how national security considerations trump economic ones).
On these complex issues, we are all facing a large set of plausible outcomes. So mindsets and planning approaches need to shift away from assuming a dominant baseline scenario with low probability tail risks.
To do this, policymakers and companies must guard even more against behavioural traps such as confirmation bias, blind spots and active inertia. And have the humility to admit that, even in the best of circumstances, mistakes are likely to happen and it is important to remain open to course correction, learning from them and others’ experiences. This does not happen without a shift from comforting groupthink to greater cognitive diversity.
Markets will punish companies and their managements if they do not adapt. Indeed, we are likely to see more financial stress and bankruptcies for businesses lacking resilience, as well as those with operating approaches that are not easily adaptable to a world of higher rates for longer. The latter includes commercial real estate whose moment of truth will materialise as more than $1tn of holdings need to be refinanced in the next 18 months.
The pressure to adapt in a timely fashion is notably lacking for institutions with managements not subject to market discipline or regular democratic elections, such as the Fed. For the wellbeing of the country, it is incumbent on these institutions to be more open to self-disruptions and for their governance structure to involve stronger accountability.
Without that, the steadying and guiding role of US institutional maturity will weaken even faster in the face of eroding credibility, turning this once dominant US comparative advantage into an even greater source of domestic and global instability.
