Recession To Follow Inflationary Period

By Lynette Bertrand, Director of Marketing & Communications

About a year ago, Dr. James Doti presented Chapman’s economic forecast to executives via Zoom, and his predictions mostly played out. At the time, he said that inflation would increase to 5.3 percent by 2023 from around 2 percent. Just 11 months since, inflation stands at 8.5 percent—much higher than anticipated. Doti said by end of year, inflation should drop to 6 percent.

His remarks were made in person this time as the Executive Leadership Summit took place in Monterey Bay, bringing together about 100 management executives, service providers, and guests for two days of networking and discussions on some of the industry’s biggest challenges and opportunities.

The sharp increase in inflation is to be expected given the increase in money flow during the early days of the pandemic. Driven by stimulus packages, the U.S. economy saw a 25 percent increase in money supply – something that hadn’t been seen since World War II, Doti noted.

While money supply has come down to 10 percent, this boost in money creation has resulted in high inflation. “Money supply will decrease to 8 percent by end of year, but the damage has already been done,” Doti said.

Other factors that are impacting the U.S. economy are:

• 100 percent increase in gas prices since January 2021

• Increase in prices across the board on products, from poultry to cars driven by demand and supply chain issues

However, the major reason for the current climate is federal spending, which totaled $7.5 trillion since 2020.

“We’ve never had this kind of fiscal expansion,” Doti said, adding that the government has run up the deficit to fund the various stimulus packages over the past two years.

Household net worth is also pushing inflation, growing from 110 trillion in early 2020 to 150 trillion in the last quarter of 2021. This wealth is fueling consumer purchasing and driving up demand and ultimately pricing.

Gross Domestic Product went to a high of 5.7 in 2021, from -3.4 in 2020, but Doti predicts it will come back down to 3.2 in 2022. For reference, GDP in the three years prior to the pandemic ranged from 2.3 to 2.9.

A year ago, Doti also forecasted a rise in interest rates to slow down inflation, and that’s also played out. Interest rates are increasing and will continue to do so this year. The 30-year mortgage rate stood at 3 percent at the end of 2021 and Doti expects that to double by the end of this year. The 10-year T-Bond also will increase from 1.6 to 3.5 percent, and the federal funds rate will go from 0.1 to 2.5 percent.

All of these measures will slow down spending and inflation but will also bring about a recession which can start late this year and into early 2023, Doti said. And the recession will impact the housing market, which for years had seen a huge boost in prices and demand due to low interest rates.

“There’s a fundamental change going on in the economy,” Doti said. “We’re moving from zero interest rate policy back to normal, which is 4-6 percent. As we go back to normalized capital, people who have taken on risk will pay the penalty.”

While average wages have gone up 5.7 percent since January of 2021, inflation has eaten up most of that gain and resulted in an overall decline of 1.7 percent.

The recession may help companies retain employees as fewer will look to make job changes or big moves during a recession.

California saw a decrease in payroll of 7.4 percent in 2020—the year of the pandemic. In 2021, payroll grew 1.9 percent, and Doti predicts more people will return to work in 2022. He said payroll will grow 4.2 percent in 2022. Still, unemployment is significantly higher in the golden state than nationally—currently at 4.9 compared to 3.6 nationwide.

In addition to the workforce, the recession will impact the housing market significantly. In 2020, total residential building permits dropped to 100,000 units but increased 14.7 percent in 2021 to 115,000. In 2022, he predicts they will be back within 110,000 or a more normal range.

Multiple family housing permits dropped from 50.2 percent to 44.8 percent from 2018 to 2021, and they will likely go back to 50 percent. However, Doti noted that history shows recessions typically bring down multiple family permits in the state so he expects overall volume will go down as this market is more volatile than single family homes.

Because of the forecasted sharp rise in mortgage rates, Doti said home prices will drop 6.5 percent this year. But while prices will drop, the doubling of mortgage rates will mean monthly mortgages will be substantially higher, even with lower overall housing prices. This will weaken housing demand because affordability will become an even bigger challenge.

Median home prices in California rose 39 percent from 2020 to 2021, much higher than nationally, which went up 34 percent. From a low of 2.8 percent in 2020, mortgage rates have shot up to 4.9 percent in April of this year and will continue to increase, Doti said.

In mid-May, the 30-year mortgage rate stood at 5.49.

Lynette Bertrand, Director of Marketing and Communications, CACM