Year End Economic Review for Business Leaders

Over the past year, the U.S. experienced an odd mix of troubling signals and economic resilience. Many sectors of the economy remained strong, but higher interest rates, increased geopolitical tensions, and turmoil in the banking sector created uncertainty about the future. This unusual situation benefited some businesses while creating major problems for others.

By understanding the factors that shaped the economy this year, business leaders can make better predictions for where the economy is headed in 2024. These predictions are vital to creating a strategy that makes the most of this unique economic situation.

Inflation Persisted

The rampant inflation that has plagued consumers and businesses since the COVID-19 pandemic continued in 2023. The PCE inflation rate, which is the Fed’s preferred gauge of inflation, was 4.7% in January – more than double the Fed’s 2% target.

Fortunately for the business community, inflation moderated somewhat throughout the year. It had fallen to 3.7% by September – but remained well above the Fed’s target. The majority of this moderation was attributed to the Fed’s aggressive monetary policy tightening.

The Fed Funds Rate Rose to The Highest Level Since 2001

In response to high inflation, the Fed began tightening monetary policy in 2022. Rate hikes continued through the first half of 2023 and the Fed brought the Fed Funds Rate to a target range of 5.25% to 5.50% in July – the highest level since 2001. Since then, the Fed held interest rates steady at that elevated level.

As the Fed Funds Rate rose, other interest rates followed including rates for mortgages, business loans, auto loans, lines of credit, and credit cards. These higher borrowing costs squeezed consumer budgets and made it more difficult for them to secure financing. In turn, certain sectors saw lower sales.

Businesses were also impacted by higher interest rates, and some were forced to delay or forgo projects that require financing. The effects of tighter monetary policy were especially significant in the bond market and banking industry.

The Labor Market Remained Resilient

Higher interest rates have historically produced the unfortunate byproduct of a weaker labor market. However, 2023 was somewhat of an anomaly.

The unemployment rate vacillated throughout the year but stayed below 4% from January through October. This is a remarkably low rate by historical standards and far below the rate of 4.6% that the Fed predicted heading into 2023.

The strength of the labor market was a boon for job seekers and workers, who continued to have the upper hand in salary negotiations. It was also a sign that businesses were weathering the higher interest rates without resorting to widespread layoffs.

The Yield Curve Remained Inverted

The yield curve reached the steepest inversion in more than 40 years in July – meaning that shorter-term bonds had significantly higher yields than longer-term bonds. This is a troubling sign because an inverted yield curve has historically signaled a recession.

Yields for long-term bonds rose throughout 2023, outpacing short-term yield growth in the second half of the year. This led to some flattening of the curve. However, recession fears were not erased.

A September analysis of the yield curve by the Federal Reserve Bank of St. Louis showed a 65% probability of a recession within the next year. While this number is troubling, there is still a 35% chance of ending the year without a downturn.

Three Major Banks Failed

Three of the four largest bank failures in American history occurred in 2023. Businesses were justifiably rattled by these failures since they called into question the safety of deposits. Fortunately for effected depositors, the FDIC took historic action to protect all deposits at the failed banks.

While depositors at the failed banks were safe, the factors that caused the banks to collapse persisted. The affected banks shared some troubling characteristics – including poor risk management strategies – that were exacerbated by higher interest rates.

The FOMC stated that the bank failures further tightened credit conditions – similar to the effect of an interest rate hike. It is difficult to differentiate the effects of the bank failures from the interest rate increases that occurred simultaneously, but businesses that applied for loans in 2023 likely felt the tighter credit conditions.

Commercial Office Space in Turmoil

High borrowing costs and the shift toward remote work took their toll on the office building portion of the commercial real estate market. There were 59.4 million more square feet of unoccupied office space than occupied space by mid-year and the office vacancy rate reached an all-time high – 13.3%.

The industrial portion of commercial real estate fared better, but still faced challenges. One of those was a record-high amount of industrial space entering the market. This influx of new buildings coupled with declining demand caused the vacancy rate to skyrocket. On the other hand, rents for these buildings continued to rise throughout the year.

With rising industrial inventory and office vacancies, certain areas of the commercial real estate market are likely to experience challenges in 2024. These complications also have the potential to create ‘spill over’ effects in other areas of the real estate market.

Geopolitical Tensions Escalated

The geopolitical climate became more strained in 2023 as war continued in Ukraine and began in Gaza. Geopolitical concerns like these tend to increase risk assessments throughout the world, which can have a dampening effect on demand and consumer confidence across the board.

The effects of geopolitics were also felt in oil markets this year as sanctions capping the price of Russian oil continued to cause friction. These markets were also affected when Saudi Arabia and other OPEC+ countries voluntarily reduced their oil output in July.

Increased geopolitical tensions could have negative impacts for businesses in 2024. This is especially true for companies who are heavily reliant on oil and those who do business in foreign markets.

2023 Economic Issues Could Persist into 2024

To tame inflation, the FOMC says they need to keep interest rates at a restrictive level for a prolonged period – likely well into 2024. While these high borrowing costs are forecasted to be effective in curtailing inflation, they could also have negative ramifications for the labor market, real estate market, and business growth.

Geopolitical tensions also continue to present risk in 2024. The lower supply of oil resulting from Russian sanctions and OPEC+ cuts is forecasted to drive prices higher next year.

Heading into 2024, many businesses are doing much of the same thing they did throughout 2023 – waiting to see how the unusual economic situation will evolve. The strength of the labor market and economic growth suggest that we could see the ‘soft landing’ that has been so elusive during past bouts of monetary policy tightening.

On the other hand, the yield curve, geopolitical tensions, and historical patterns suggest we could face a recession. In either case, businesses that are prepared for changing economic conditions have a better chance of success.

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