AMG is closely watching the Federal Reserve’s (Fed) war on inflation, and so should you. The central bank’s moves could well affect events investors see unfold in the coming year.

A critical issue for 2023 is how committed will the Fed be to achieving its longstanding goal of 2% annual inflation growth. Will it aggressively pursue that target? Or will it reconsider, accepting a higher inflation rate going forward?

The higher the Fed boosts interest rates (the Federal Funds rate currently stands at 4.25% to 4.5%), and the longer it keeps them elevated, the more likely the economy is to slip into a recession. Currently, AMG expects a mild downturn sometime next year with some interesting outcomes. For example, we don’t expect unemployment to exceed the 5% range (it currently sits at 3.6%). It could fall even lower, especially if inflation heads toward 2%.

Such a recession—with GDP modestly in the red for two to three quarters—would suit the Fed. It would allow inflation to be tamed while most people remain employed and financial markets begin to recover.

However, maintaining high employment—with wages increasing as they are now—could prove tricky and keep inflation from dropping quickly into the 2% range. How could that happen? Easily. Currently, there are slightly more than 6 million unemployed workers and some 10.1 million unfilled jobs.

If unemployment stays low and consumer spending stays healthy, the Fed might have to make a tough decision when it comes to bringing inflation down to around 2%: Does it continue to aggressively boost interest rates and push the economy into recession, or does it accept a new normal—inflation in the 3-4% range—and allow the economy to modestly grow and keep unemployment below 5%?

Either choice could dramatically influence most asset prices over the next 24 to 36 months.

Also on AMG’s radar in 2023 are:

  • The unintended consequences of the Ukrainian War. Escalation of the conflict and irrational aggression by Putin could throw the world into economic turmoil. The shortages of commodities, raw materials and impact on energy prices have subsided for now, but any escalation of the war could throw the European community into a deep recession.
  • Does China find a solution to its COVID-19 woes? If it does, their economic recovery will impact everyone as global supply chains are restored. For developed countries, especially Europe, Chinese growth means more importing of machinery, cars, and high-end consumer goods. For the developing world, a healthy and growing China means more exporting of raw materials and agricultural products.

A lot of vexing questions should be answered in 2023 and determine the strength of the U.S. and foreign economies for years to come.

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