Moody’s Economic Update: Possible Challenges Ahead, Reasons for Hope

As we approach the halfway point of 2023, the economy faces multiple headwinds. From debt ceiling negotiations and the banking crisis to the Fed’s interest rate hikes, how will these events impact the second half of this year?

In our latest Market Pulse podcast, we turned to David Fieldhouse, Director of Consumer Credit Analytics at Moody’s Analytics for a mid-year economic update. We covered various topics including:

• An update on the debt ceiling crisis and possible long-terms effects

• Moody’s outlook for the second half of 2023

• How the financial industry can prepare for economic headwinds

• Reasons for cautious optimism

Listen to episode 26 of the Market Pulse podcast for our full interview or continue reading for an excerpt from the discussion.

We’re almost halfway through 2023. What is the Moody’s analysis for the second half of this year? Is a recession still likely? 

David: When considering the economy's future, it's important to remain cautiously optimistic. While there will undoubtedly be challenges ahead, we can find reasons for hope. We do think GDP growth will slow and employment progress will stall. However, there's a chance that we avoid a recession despite the high inflation and aggressive petrol-reserve policies. The current pessimism about the economy may be overstated. Inflation is still a concern but is cooling down and could reach the Federal Reserve's target by next year. 

There are several reasons for optimism also. First, households saved much more during the pandemic than they would have under normal circumstances. Furthermore, businesses are doing their best to avoid laying off employees, and household and corporate debt burdens are relatively low. 

There are some areas of concern. Low income and younger households have taken on more debt during the pandemic, and lenders have lowered their underwriting standards. So, we have to watch the credit conditions overall. But there is no real sign of real estate market oversupply or household demand being exhausted. Instead, housing is significantly underbuilt and there is pent-up demand for other durable goods like vehicles. 

Unlike previous recessions, state and local governments will not be a significant drag on the economy. They're unlikely to face fiscal difficulties because tax and revenue streams have not faltered as much as they have in the past. 

So, we need to be realistic about the challenges ahead, but there is cause for hope that the economy will manage through the rest of the year, and it may be muted, but we may be able to avoid a recession. So, we are cautiously optimistic.

Given all that, what should the financial industry do to prepare?

David: I think they've already been taking steps to prepare. We can look at the Senior Loan Officer Survey, and we'll see all types of non-federally backed commercial and consumer credit have seen sharp tightening in lending terms in the January and April surveys. We expect this tightening to be a drag on credit growth for the rest of the year. That will lead to some stalling in economic activity, and the amount of tightening leading up to where we are today is like what we saw in 2001 and 2008. And it's one of the many reasons that economists and pundits are arguing against the most recent rate hike by the Fed. 

We have seen some tightening in the credit industry overall. Specifically, we're seeing more tightening with large banks relative to small banks, and that may reflect a little bit of a different risk tolerance out there. So, lenders have been taking note of the current conditions and they've been preparing, which will help them going forward. 

I would say that lenders should be open to making loans when conditions are tight because they may have some of the best opportunities. Although there's a real question about the risk tolerance that they want to take on, there are opportunities out there. So be diligent. Be careful with the loans that you make. But there is some upside risk because just everybody's so cautious right now. So, some lenders might be in a situation where they can lean into that.

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The Market Pulse podcast is available wherever you listen to podcasts. Be sure to check out past episodes, including:

• Optimizing Your Marketing Strategy in an Uncertain Market

• How Lenders can Navigate This Credit Tightening Environment

• Why Financial Institutions Need a Deposit Growth Strategy

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