November 10, 2022
GDP growth rose 2.6% in the third quarter after having contracted in the second quarter by 0.6% and having fallen by 1.6% in the first quarter. We expect GDP growth to be between 1.0-1.5% through the end of the next year even though the Fed continues to push rates higher because the economy continues to create jobs, wages keep rising, and real interest rates will remain negative through midyear..
Given the GDP forecast above, we expect the unemployment rate to be 3.7% at the end of 2022. .Given GDP growth of 1.1% next year we expect the unemployment rate to rise 0.4% to 4.0% by the end of 2023. As the Fed keeps tightening the economy will slip into recession in the first quarter of 2024. As that occurs the unemployment rate will peak at 5.0% by mid-2024 before retreating to 4.2% by the end of that year..
Given the rapid increase in money supply growth, the core CPI inflation rate rose 5.5% in 2021. It now seems likely that the core CPI will rise 6.1% in 2022. But with money supply growth having slowed sharply some of the excess liquidity in the economy should be eliminated by the end of 2023. We expect this core inflation measure to slow to 4.3% in 2023. Slower, but still not even close to the Fed’s 2.0% objective. Once the economy enters recession in the first quarter of 2024 the inflation rate should subside quickly and dip to 2.5% by the end of that year.
Following the November FOMC meeting the Fed raised the funds rate to 4.0%. It also indicated that it expected the funds rate to rise to 4.5% by the end of this year. We expect the funds rate to reach 6.0% by the spring of 2023,. If the Fed raises the funds rate to 6.0% by the middle of 2023 and the inflation rate slows to 4.4%, the real funds rate would finally be positive at +1.6% (6.0% – 4.4%). For the first time in four years the real funds rate would be positive which would finally give the Fed a chance to slow the economy enough to reduce inflation and bring it closer to the 2.0% target. We expect a real funds rate of that magnitude will cause the economy to slip into recession in the first half of 2024, but then recover in the final two quarters of that year.