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I am Chris William.

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In a moment, we will unpack what may be surprising about the economy and everything related from jobs to lending to interest rates with our resident economists.

And we start right now.

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On this edition of Carolina Business Review, the economic forecast for 2023, featuring Dr. John Connaughton of UNC Charlotte, Dr. Laura Ullrich of the Federal Reserve Bank of Richmond, Dr. Frank Hefner from the College of Charleston and Sarah House of Wells Fargo Securities.

- Hello and welcome again to our program.

Sarah, let's start with you.

What do you think is gonna be a biggest surprise?

What will be the breakout that we don't see coming?

- Well, I think one big surprise that we could see is potentially just how tight the Fed keeps policy this year.

So if you look at where markets were expecting policy to be after the Fed's final meeting of this past year.

So they're still looking for rates not only to get as high the Fed expected, but also some cuts in the back end.

And I think even as we see the economy head for a downturn and likely to see the unemployment rate rise pretty markedly here, that the Fed's going to stay the course and make sure that inflation is well and truly back in the bottle.

And, and I think it's a different reaction function that a lot of people just still don't believe.

- You think the Feds staying higher for longer is what you're saying?

- Higher for longer.

It's been a message they've been trying to push.

I don't think markets have have quite listened, but I think they could be in for a wake up call next year.

- Yeah.

So the Fed is actually the parent in the room when it comes to the economy to some degree, you think?

- Let's hope so.

- Yeah, okay.

- Someone has to be.

- You know I can't ask you that question.

(group laughing) What do you think?

It's a big surprise.

- Big surprise?

Well, you know, I think that it'll be interesting to see in February meeting when the, the FOMC board changes a little bit, whether or not Sarah's right.

Certainly, you know, Jerome Powell has been very- - You said monetary policy then in general is gonna be> - Yeah, I think monetary policy in general is gonna be the issue.

I suspect that the Fed will get a little bit queasy and probably not go to five and a half percent, which is what a lot of predictors are suggesting right now is where they're gonna go and where they're gonna cap.

I wouldn't be surprised to see 25 basis points in February.

- [Chris] Okay.

Frank.

- Well, a number of things.

I think if the international scenes stabilize a big surprise with the Ukraine issue was completely done.

And if Russia re-organized, which probably is on the horizon, I think that's gonna be a big takeaway for next year.

The inflation issue, of course, is gonna be the big one, and how the Fed responds to that.

Possibly, I would say the disconnect between inflation and unemployment.

So that would be very surprising.

So the idea is that, is it necessarily true that in order to break inflation, we're gonna create unemployment?

- Yeah.

- And that to me would, that would be a breakout point.

- Okay.

- Biggest surprise for you Laura?

- I agree with Frank on that, and I think, you know, it's kind of long been debated in my, you know, how much does the Phillips curve matter?

Does it exist?

- Right?

- Does it, should we just throw it out?

I can tell you what I hope the biggest surprise is that we keep seeing positive CPI reports like we saw this past week.

And right now, you know, people will ask me, how high do you think rates will have to go?

Or, you know, when do you think we'll go into recession?

Will we go into recession?

And depending on what data has just been released, there's times when I feel more positive or less positive.

But right now we're in a situation where, at least right now, prices are coming down.

Consumer spending is remaining pretty resilient, employment's remaining strong.

So I hope that the biggest surprise is that we get a softer landing than many people predicted in the first place.

- Laura, John just talked about five and a half percent.

A lot of people call that the terminal rate, and this is an academic question, but why is the terminal rate important?

It's talked about so much, but why the terminal rate?

What does that mean?

- I mean, I think a lot of these rates, like we've had, it has been such a long period of time since we've had increases in interest rates, right?

Really meaningful increases in interest rates.

And so, I think a lot of these macroeconomic terms, whatever they are, whether you're talking about terminal rate, Phillips curve, I'm not really sure we know exactly what it means anymore.

I mean, we're in a really different economy.

We're in more of a global economy.

We are in the midst of different demographics than we had 40 plus years ago when we had inflation and rates like this.

So I think in- I'm a microeconomist, but in macroeconomic circles there's a lot of debate about all sorts of, all sorts of policies and the existence of certain things that we learned about in textbooks that may no longer be relevant.

So I'm not sure I think of it as being as as important as maybe some other people.

- And I don't think the Fed itself worries about the terminal rate.

- No, I don't think so either.

- They worry about the neutral rate.

- Yes.

- Here we go, more jargon.

- That's great.

(group laughing) - And basically they, that's the rate at which, excuse me, that's the rate at which above that rate monetary policy is contractionary, below it, it's expansionary.

They're we don't know what the neutral rate is, they don't know what it is, but they do have an estimate and they're looking at about four point a half percent.

So, when they hit four and a half percent, which they're getting close to hitting, then at that point in time monetary policy, in their eyes, becomes contractionary.

So that's- - And that's about a soft landing, that's what they're trying to moderate.

- Yeah, right.

- But I think before this, a lot of people thought the neutral rate was below 4.5%.

- Yeah.

- That you would start seeing bigger pullbacks.

So that's what, but you know.

- But the whole concept of a soft landing presupposes that you have to create a recession- - Right.

- in order to break the back of inflation.

And I'm not a hundred percent sure that that's always the case.

You do have to restrict money growth in order to reduce inflation.

You don't necessarily have to create a recession.

- Yeah.

- The real bugaboo in all of this has been something you said you all talked about on the last time we were together on the previous program and the idea of the job- how did you call it?

- 'Job full recession'.

- 'Job full recovery'.

- So Sarah- - Recession.

- I'm sorry, 'job full recession'.

Sarah, how is labor gonna unfold this year?

- So we think that it's gonna be a harder year for the jobs market.

So even at the end of this- - Meaning higher unemployment?

- Higher unemployment, we think we'll actually see some net job losses in the second half of the year.

And that's coming from the fact that given the higher financing environment, the slowdown in growth, the uncertainty, the squeeze on profit margins, that's gonna have an impact on both business investment as well as the number of workers that businesses are able to hire.

There's a lot, there's still a lot of job demand out there, so we don't think this is right around the corner, but we have seen measures of labor demand begin to roll over.

So everything from the number of small businesses saying they have at least one job hard to fill, just the sheer number of job openings in in the economy.

You're seeing even just turnover slow down in terms of people just job switching less.

So we are seeing the labor market cooling, layoffs ticking up a little bit.

So still at historically low levels, but I think we have seen the tide begin to turn a little bit.

And I think just given the cost of labor, so that's one thing we haven't really talked about is that's I think going to be a key source of inflation pressure next year, is yes, we're seeing improvement in supply chains.

Yes, we're seeing energy prices come down, that's all great for the inflation picture, but it's gonna be hard to get inflation back down to 2% on a sustained basis if you still have labor costs running 5 to 6%, like the most recent data has pointed.

And so that's gonna be key is seeing that labor market cool if we really are gonna get inflation back towards the Fed's target.

- And things maybe forward are gonna look different because of demographic shifts.

We're gonna be in a tighter labor market.

I mean we're gonna have lower labor supply for quite a while.

- It's pretty low now, right?

- Yeah.

But it's gonna get even worse.

I mean especially if you look at, I mean my, I would think so anyway, and especially if you look at even the number of hours younger people wanna work compared to what their parents worked.

You might have the same number of people working, in some cases, but it not equaling out to the same amount of work, right?

And so I think based on a lot of trends we're seeing, we're gonna be in a low labor supply environment for quite a while unless we have some major change in immigration policy or something like that.

And so to Sarah's point, that would lead you to believe that wage growth will likely be higher than we saw before this.

And so, I think I agree with what Sarah said, It's hard to be at 2% if wage growth is as high as it might end up being.

- In the Carolinas, we will get migration.

- Yep.

- Yes.

- It doesn't have to be foreign.

We are getting in-migration from across the country, and that's what's really helping us out on our labor force.

And given everything that's going on, at least in South Carolina, we need that in-migration because we just don't have the workers.

- But you know, the big thing that the fed's gonna face this year is the so-called wage price spiral.

- Right.

- And we've already seen indications at the end of '22 about this.

We saw Delta airline pilots agree to an enormous raise.

It's over five years, but it's still pretty significant.

We're not sure what's gonna happen with the railroad workers, but they're looking at a pretty significant raise.

It's, again, it's over five years, but still it's quite significant.

And the big issue is in the service industry where those wages are going to continue to have pressure there because they're still not back up to historic levels in terms of employment in the service industry.

So that's gonna be a real problem the Fed is gonna have to face.

We still have 10 million unfilled jobs.

Okay, that's not changing.

As Sarah mentioned, we've got, you know, this, the layoffs haven't really been coming that heavily.

We don't see new filings for unemployment insurance that are up, they're still at pretty low levels.

So, you know, you may be, I hate to admit this, Frank, (group laughing) but you may be right about the job full recession, we may see GDP start to slow.

We may have another quarter or two GDP decline this year.

It's still iffy.

- But, I'm concerned- - But I'm not sure the employment rate is gonna rise very much - The channels here being a macro economist, I mean, there is no interest rate policy that'll get you more airline pilots.

It just won't happen.

- Oh.

- And the other thing is in a lot of, and this is something you might want to address 'cause of the labor markets things that you have analyzed, is that we have a labor shortage or is it a disconnect between the jobs that are going to be open and the people that are available?

- Yeah.

- Because you can raise wages and you're not gonna get more pilots for a while.

- Okay, before Frank takes over his moderator and tosses it- (group laughing) - Thank you though Frank.

- Certainly.

- I wanna, let's look past the work from- - One job, but good job.

(group laughing) - Alright, stop it you two.

Let's go past the worker's comp issue- - Right.

- of workers and labor and let's talk about productivity.

What does that look like, and how does, and yeah, I know, how does that affect all of this?

- Yeah, it's gonna have a big effect on it, and- - [Chris] Is it going up?

- Well, it's been going down, and I think workers are sending signals about how the world has changed.

And some companies are adapting and some are not.

And the ones that are not adapting are gonna struggle because we're in a different paradigm now.

- Do the workers hold all the cards?

- Well, because of the, they don't hold all the cards, but if you look at labor force participation rate and labor supply, they're gonna hold more cards than they did before.

I don't think we're gonna be in a scenario where companies think, well, I don't like the way Laura is working.

I'm gonna get rid of her and tomorrow I'm gonna hire Sarah, and she's gonna come in and be just as productive and just as good.

Companies I think are gonna be slower to layoff because they're afraid that they can't hire somebody.

And I think workers are going to hold more cards.

If you look at kind of the landscape of labor and what, you know, think about manufacturers, what they used to provide their people, right?

I mean, there was mill housing, there was a company store.

If you sure worked really hard, you got a little coupon you go get yourself a ham at the company store or whatever.

They provided a more holistic set of benefits.

That ended because women rushed into the labor force and the baby boomers entered workforce age.

And so they didn't have to do that anymore.

You know, there was an excess supply of labor.

We're just not gonna be in that world anymore.

And so I think that's why you hear companies talking about providing childcare on site or providing housing subsidies or, I mean, we even have heard some, you know, the Cherokee casino, they purchased a manufactured home company to be able to provide their people housing.

So I think that's why we're hearing some of those conversations because companies, some companies, are adapting and are aware that this isn't just about Covid.

There's other things going on too, and so going forward it looks different.

- Okay, and I know you wanna weigh in on this and I know you have a good opinion on this, but Sarah, I also, I want to ask you as the cycle of this new working model seems to be longer than a couple years or maybe even three years, that this is going to be a very long learning cycle for both employers and employees.

So as it mod- as it moderates, and the employees start losing some leverage and companies have lost leverage, I mean, how does all this play out?

As Laura just talked about it, how do you see that model?

- So I think we need to separate the cyclical sides from the longer term secular trends.

So I think kind of where we are in the cycle, we're starting to see workers' position get a little bit weaker as I think businesses are getting a little bit more conservative.

They're looking ahead at potential downturn.

And so they're, they're just thinking twice about, you know, do I need that additional worker?

And so, but then I think we also have to couple that with those longer term demographic aspects that we're seeing in terms of just the sheer slowdown in the working age population.

You couple that with, you know, lower participation rates across some key cohorts within that group.

And then you are looking at, I think on, you know, for any point in the cycle, a potentially tighter labor market just given those demographic trends.

And so that's gonna have impact on wages, it's gonna have impact on inflation, and therefore it could potentially have an impact on kind of what that longer term rate of interest rates are.

- Do we know what productivity is gonna be for remote workers?

Is it better?

- It's unclear.

- We really don't know.

- Yeah.

- Okay.

- But you know, back to that original productivity question.

First two quarters of 2022, productivity declined by more than any period in history going back to 1947.

So we had really serious productivity declines in the first two quarters of this year.

And that's a big thing.

But, you know, back to this, this issue about the demographics and the changing demographics.

Here's what I'm really looking into at 2023 that I'm kind of curious gotta keep my fingers crossed.

We're gonna have divided government.

Republicans is gonna control the House, Democrats are gonna control the Senate and the presidency.

And one of the ways that you can get yourself out of this problem, we're gonna have a problem that none of us have ever experienced before.

And that's a labor shortage; it's clear about that.

Retirees are gonna outnumber a new entrance.

So immigration- - So you think it's gonna get even worse than it is now.

measurably in- - Unless Congress becomes adults and decides they're gonna have a comprehensive immigration reform.

- Okay.

That's not just gonna be an open border, and you know, whoever can scramble in, scramble in, but we can start to selectively pick and choose occupations to help supplement, you know, as Sarah was mentioning before about there's a mismatch between what companies need and what labor is out there.

That could be part of the reason we have 10 million openings, okay, unfilled openings.

So this is a big issue, and we've been, you know, we have been experiencing talk about immigration reform for over 20 years.

I mean, it goes all the way back to the Reagan administration.

- You think fiscal policy's gonna have to catch up with real world- - Duh.

- You think congressional action is gonna happen?

- Yeah not, this is just congressional action on a particular issue.

- Okay.

- That could eliminate some of the problems we're having right now.

- Frank.

- Sounds fine to me.

I mean, I mentioned we need workers and if you're talking about South Carolina, we get 'em from Ohio, that's great, but where's Ohio get their workers?

And in a lot of the lower skilled jobs we have in migration from overseas quite a bit in the area.

So that's gonna be the key for providing this.

As far as the labor issues and productivity, the businesses, especially in retail I've noticed, they're reluctant to hire that extra person.

And the customers are noticing that because you go into some of those retail stores, there's just no one there to help you sometimes.

And then they're also, the managers are putting more pressure on the people that are working to perform more.

And that, the only way you're gonna get that is by either offering more amenities or a higher salary.

- Something related, but off of workers, but certainly workers need housing.

We've seen what housing prices do when you own, what's housing gonna look like in 2003?

- I mean, I think we're gonna continue to see, as rates go up, it's gonna become an increasingly difficult environment, right?

In housing and already in places like Raleigh and Charleston and Charlotte, we weren't building enough houses to keep up with the in-migration.

And so I think we're gonna see fewer houses built, probably, than we would've seen other, you know, other lives- - Because of the cost of money?

- Because of the, yeah, because of the cost, and people just, I mean, you know, you sit down to do that calculation of what house you can buy.

If your mortgage rate is 7 or 8%, it looks a lot different than if it's 3.5, right?

So, I think that it's just harder for families to buy homes at that those rates.

I think we continue to hear that multi-family is a strong market in most of the Carolinas, but we also have an issue in the south of comp- you know, nimbyism and communities not wanting the density that we really need to be able to accommodate the workers that we need.

So to me this is gonna be an ongoing problem into 2023, and one that communities are gonna continue to struggle with.

- Does affordable housing become more a bigger issue in 2023, now, because of some of the things that Laura said, but also because of the momentum?

- I think it'll stay an issue.

I'm not sure if it'll be more.ú I mean it's been a huge issue even in the past, even in the past few years, just given the run-ups we've seen in rents, as well as home prices.

And so I'm not sure it'll be more, but it's an ongoing issue, and I think one thing we've seen is that, you know, if we're talking about inflation being a problem in overall prices, well, you know, we saw this huge run up in home prices, but really we haven't seen much give back in terms of prices just because where so many people have low mortgage rates, they're not putting their homes on the market.

So households are getting locked in place and with that low inventory, you're not seeing much downward pressure on prices.

So we've seen this hit to affordability, but builders can't make it up and so, we're keeping supply constrained.

And so I think that's gonna keep this affordability issue very much in play this coming year.

- Affordable housing's been a problem since the great recession slash financial recession.

Regulations and that were put in, policies that were put in has made it very, very difficult to easily construct new houses on spec.

So yeah, its, it goes back a ways and it's not gonna get any better going forward.

- Is there an economic solution for affordable housing and I mean affordable housing and being able to afford a home, but also affordable housing for those that are at greater risk and can't even buy a home and want to buy a home?

- Well, that's a good question.

I mean, yeah, there's an economic solution.

Triple my salary, so that I can afford the 7%.

I mean my first mortgage when I first bought a house was 7%.

So, but the house was- - But the price was a lot lower too- - A lot lower also.

- Right.

- So that's the thing.

And housing prices tend to be very sticky.

They tend to go up faster than they ever go down.

So you run into that issue.

But we're running into it across the board.

Educators, the public school system, can't afford to live anywhere near their schools.

In many communities in North and South Carolina school boards are having to raise salaries to attract teachers.

And so this is gonna have longer term public finance ripple effects.

'Cause once you increase their salary, you don't really get to ever take it back.

So that ends up being that problem.

It's gonna create other issues for us though, besides labor, existing labor, but given so many projects in South Carolina are on- - Economic development projects - Economic development projects are on the books.

They're, I mean, we've got the huge battery recycling plant coming into Berkeley County.

They're looking at possibly hiring 1500 workers.

Well, they're not gonna get 1500 workers from the Charleston metropolitan area necessarily.

So that's gonna be more in-migration, that's gonna put more demand on housing.

- [Chris] Go ahead John.

- Historically, affordable housing has come from what urban economists call filtering process.

- Right.

- Which is where houses filter down and become lower rent or lower priced.

And we've seen an end of that in this century, essentially, so that these older neighborhoods where the housings would come a little bit in disrepair and the rents would drop or the prices would drop, they're now being snatched up and being gentrified.

I mean we see it here in Charlotte, for sure, where they go into neighborhoods and they just basically, you know, buy the property, tear the house down and start all over again.

- The corporate landlords have been blamed for that.

Is the dark overlords, is that true?

- I don't know that they're the problem per se.

They're, they could be part of the problem, but you know, I mean, and there has been a tremendous change, but again, it's just simply the number of units and if you're not building, you know, new construction is a lot more expensive than used houses.

If you're not building new construction, you don't have that filtering process taking place.

People are saying, well I want- I'm not gonna buy a new house.

I'll buy something and fix it up.

And you go through neighborhoods in Charlotte, you go through neighborhoods in Columbia, you go through neighborhoods in Charleston and this is happening all over.

- Yeah.

Laura, that's the dark side of economic development.

Does that ever change or is this how in-migration and the move to the new south is this what we have now?

- I think there are policies that could change it.

I think there are things, you know, I think we've had movement towards a lot of local policy that's made it very difficult across the country.

But in multiple places in the Carolinas we've had restrictive, I mean we've had moratoriums placed on multifamily that makes it worse.

We've had, you know, like I mentioned the nimbyism, but you know, requirements where you have to have an acre per lot in some places, like, just things that make it even more difficult.

And, and so I think there could be potentially some policy changes over time.

There's also, I know there's some people, people in Charlotte that are work on working on, you're actually allowed to put what they call an accessible dwelling unit at ADU in a backyard.

It's like a tiny house, but there's no way to finance that.

So if I own a house in a neighborhood, maybe it's a neighborhood that is being gentrified, prices have really gone up and if I sell my house, I've got, you know, I'm kind of in a difficult spot.

- So change governance to allow lenders to underwrite those.

- I could put a accessible dwelling in my backyard, but right now I have to come up with a cash to do that because you can't, so there's a policy, you know, a financial policy that could happen there.

So I think there's- you know, there's always an economic answer.

It may not be very politically tenable at times, but its always an economic answer.

- And it may not require that you move to Detroit either.

- That's right.

- Where housing prices are a lot more reasonable.

- [Chris] We have about a minute left.

John, I'll start with you very quickly.

Do you think there is a recession that will start in 2023?

- About one-third, yes.

Two-thirds, no.

- [Chris] Okay, that's close enough.

Laura, can you forecast that?

- I put it about 50/50 for me, but if there is a recession, I am hopeful that it would be mild.

- [Chris] Okay.

- So we think that there will be a recession at Wells Fargo if it's our baseline, it's not a guarantee, but we'll say 60/40 recession.

- [Chris] What about you?

I know Wells Fargo says that, but what about- - 60/40.

(group laughing) - [Chris] Nice cover.

- Depends on all those economists at the National Bureau of Economic Research and what they're looking at, whether we actually call it a recession, things will slow down, that's clear, in a lot of different markets.

But will they, will it be dire?

Will this cause major pain for most people?

Probably not.

Yes, there will be select people that will feel it, but no, it'll be a pretty good year next year, yeah.

- Okay.

Well that's the end and we'll play this back to you.

- Okay.

- And a year after that, 'cause I know Sarah loves that.

But thank you all for coming, and I genuinely mean this.

Appreciate your participation on this over the years.

- Thanks.

Frank, thanks for traveling in from Charleston.

- Thank you - Sarah, always nice to see ya.

Dr. Ullrich, good to see you as well.

- Thank you.

- And John thanks for being- John was one of the panelists on our very first program, so thanks for sticking with us.

Until next week, I'm Chris William, happy holidays.

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(guitar music playing)