Interest Rates and the State of Markets in 2023

Chicago Booth experts convened in January to discuss global issues at the first of several annual Economic Outlook 2023 forums. Their insights come at a time when the world continues to emerge from the social and economic disruptions of the COVID-19 pandemic, with countries and companies struggling under a host of problems. These include the worst inflation and the highest interest rates in 40 years, shifts in supply chains and the labor force, and the threats posed by climate change and ongoing geopolitical tensions.

This year’s panel consisted of Wenxin Du, professor of finance and a Fama Faculty Fellow; Randall S. Kroszner, the Norman R. Bobins Professor of Economics; and Raghuram G. Rajan, the Katherine Dusak Miller Distinguished Service Professor of Finance. The forum was moderated by Kathleen Hays, global economics and policy editor for Bloomberg Television and Radio. During opening remarks, dean Madhav V. Rajan noted Booth’s 125th anniversary and highlighted Economic Outlook as a prime example of the school’s long history of informing public discourse.

The event—the first in-person Economic Outlook forum since the advent of COVID in 2020—was held at the Sheraton Hotel in downtown Chicago and was attended by approximately 350 guests as well as more than 600 online participants. Panelists weighed in on a wide range of topics, including the US Federal Reserve Board’s efforts to tame inflation by raising interest rates, the chances of a rate cut, the state of markets as China loosens its COVID restrictions and the country reopens, and broad concerns heading into the new year.

How High Will Interest Rates Go?

“I’ve been saying for a while it will be mid-fives,” said Kroszner. “We’re still in a period where unemployment is at a 50-year low, and the Fed is waiting for the labor market to crack before pausing.”

Rajan agreed but added that wage growth has slowed and there is some evidence—especially in the tech sector—that layoffs are increasing. “The Fed is looking for signs that will allow it to slow down,” he said.

The reason the Fed is being so cautious is that it doesn’t want to be responsible for triggering a deep recession, Rajan added, “especially since Congress has just spent $6 trillion on the best recovery money can buy.”

Whether mid-fives will be enough remains to be seen. “I don’t think anyone knows,” said Rajan. “The Fed has certainly done enough to counter criticism that it is behind the curve. But beyond that, I think you have to be a little agnostic and admit that there’s a lot of unknowns, a lot of possibilities. The Fed’s biggest fear is if they pause or stop, people will start spending again and the whole problem will just repeat itself.”

The panelists generally agreed that there would likely be a mild recession toward the end of the year.

“The Fed has enough tools to keep the situation from getting out of control,” Du said. 

Kroszner commented that the Fed is hoping to achieve an “immaculate disinflation” that avoids both a recession and any increase in the unemployment rate. The problem, he said, is that “we’ve never seen that happen before and I don’t think it’s likely.”

Is There Any Chance of a Rate Cut?

The panelists as a group expressed doubts about the possibility of the board cutting rates. Riffing on a famous line from 1980 speech by Margaret Thatcher, Kroszner said, “The Fed is ‘not for turning,’ for pivoting.”

He added that “the last time inflation rates were this high was 40 years ago, and back then interest rates were in the double digits. People have lost context on this because it was two generations ago. But that is why Fed chairman Jerome Powell keeps referencing Paul Volcker and the importance of not pivoting too early.”

Rajan commented that the reason the Fed is taking a hard stance on inflation is because it lacks credibility as an inflation fighter.

“We’re coming out of a period where inflation was very low and the Fed’s job was actually to get the inflation rate up,” he said. “Now the dynamic has changed and they have to convince the market that they mean what they say.”

There is one big asterisk, however. “If we’re clearly going into a recession and we start seeing big job losses, they may cut rates mildly,” Rajan said. “But probably not this year.”

How Will the Reopening of China Affect Global Markets?

Among the range of opinions this question elicited, Du offered, “It’s going to take a while for the Chinese domestic market to come back, but when it does there will be strong pent-up demand.”

Rajan added, “As Chinese demand comes back, it’s going to put upward pressure on global commodity prices.” An example, he said, is natural gas. “Europe is currently benefiting from lower natural gas prices because the Chinese have not been competing. That will change in the next year.”

Kroszner, however, offered some hope on that front. “Germany recently built a liquified natural gas plant in six months. This would normally have taken three years. They did it by streamlining and eliminating a bunch of regulations. There’s a real lesson there that if you put your mind to it, you can really get things done.”

Kroszner also expressed doubts on the revival of the Chinese domestic market. “There has always been a very high personal savings rate in China because of a lack of trust in the government to provide healthcare and other services. The lesson people have learned from the pandemic is that this will continue. So while the domestic market will definitely come back, it won’t snap back quite like the US did.”

China also plays into predictions regarding the global supply chain. Because of the disruptions caused by the pandemic and the war in Ukraine, companies are looking to expand their options. “Everybody wants what I call a China Plus One policy,” said Rajan. “Companies want more flexibility with their supply chains. Instead of just-in-time, they’re moving toward a just-in-case strategy.”

The economic upsets of the past few years have also scrambled the outlook for emerging markets such as India, Brazil, Mexico, and the Philippines. “If you take them as a group, they had a bad pandemic. The upper classes did well but the governments couldn’t support the lower middle classes with the kind of fiscal transfers that happened in developed countries,” Rajan said. “In India, for example, auto sales are going through the roof but scooter and motorcycle sales—which is how the lower middle class gets around—are still on a downward trend.”

The result, he said, is that “the lower middle class is hurting and that is starting to have an effect on politics. People want change.”

What Are the Wild Cards for 2023?

“I worry about climate change and how little we’re doing about it,” said Rajan. “I worry that we’re going to see big catastrophes that will lead to enormous migrations and chaos in the developed world.”

Du expressed concern about government inaction. “I’m very worried about political polarization and the ability of governments to function,” she said.

Kroszner noted that the possibility of geopolitical tensions exploding into “hot wars” remains very high. In addition to the war in Ukraine, “there’s currently a war in Yemen and there are problems in Iran and the Middle East. And then there’s China and Taiwan. So I would say that’s the big thing that’s very difficult to put probabilities around, but that I would worry about.”