North American Outlook – Inflation Is The Focus

This article originally appeared in the March issue of Manufacturing Outlook. For a limited time we are offering a FREE subscription to Manufacturing Outlook, our monthly manufacturing newsletter. For more details, Click Here.


by Chris Kuehl

I suppose I have offered the same definition of an economist about a thousand times by now.  “Somebody who explains tomorrow why the predictions they made yesterday didn’t come true today.”  It is just that this is so very accurate.  The problem is that the data shifts nearly constantly.  At its heart, economics is a social science (despite our attempts to use numbers as if we were a “real” science).  We study human behavior, and there is no creature on Earth less predictable and volatile than a human being.  You remember your beloved Econ 101 class, where the professor valiantly tried to assert that people “maximize expected utility.”  The reality is that people rarely do this – they react to everything they shouldn’t pay attention to and ignore what they really should be paying attention to.  What does this mean when trying to puzzle out what to expect for this year’s economy?

Basically, there are two schools of thought competing with one another on the subject of recession.  There are the true dismal scientists that are predicting a recession in 2023 and a fairly deep one.  They point to a variety of factors ranging from a slowdown in industrial production to slumping retail and the retreat seen in measures such as the Purchasing Managers’ Index.  They mostly assert that the central banks are still committed to dealing with persistent inflation, and that will propel them towards even higher interest rates.  They cite the comments by Jerome Powell as he indicated that inflation, as measured by the PCE (Personal Consumption Expenditures), is still over twice as high as the Fed prefers.  They want that rate at 2.0% or slightly below, and right now, it stands at 4.6%. 

The other school asserts that 2023 will see nothing more dramatic than a minor downturn that starts to evaporate by the 2nd or 3rd quarter.  They look at the fact that inflation has started to erode (probably peaked at the end of Q4 2022).  They believe the Fed will slow down their rate hikes, and they point to the still solid jobless numbers.  They look at the fall of commodity prices and the surge in industries such as automotive and aerospace. 

If one looks at the data that comes from the Armada Strategic Intelligence System, one will observe that we are somewhere in the middle.  In the latest issue of the CCAI report, we showed the latest ASIS model for industrial production as a whole.  There was a substantial peak in 2022 – a holdover from the rapid growth that was seen in 2021.  That started to ebb last year and is expected to keep dropping for a while this year before tracking back up to what it was in the last decade.  It is interesting how close the numbers are to the ten and twenty-year trend lines.  In the more detailed breakdowns, we see some significant variations – booms in automotive and aerospace but declines in machinery.  Less volatility in fabricated metal and more volatility as far as primary metal is concerned.

What is the conclusion one can draw from all this?  The first is that there is a substantial degree of uncertainty to contend with, and that forces companies to develop a wide range of contingency plans.  The outlook for the coming year depends on factors such as the Fed’s willingness to halt or even reverse rate hikes.  There is a fear that political gamesmanship will lead to a default over the debt ceiling, and that could shove the economy into reverse.  Global activity will play a huge role as well.  Does China finally resume its production activity, or has the world moved on enough to blunt that impact?  Commodities have been down, but there are still major disruptive threats to the oil supply as well as industrial metals.  Leftist regimes in Latin America have already impacted copper, aluminum, and other metals.  Europe asserts that it is no longer staring a recession in the face – at least not a severe one.  Does that mean more market for U.S. goods or more competition from European producers?  Probably both.  The bottom line is that companies are facing a year of unknowns after a couple of years of predictability.  We all knew 2020, and much of 2021 would be miserable, and we knew part of 2021 and 2022 would feature growth – we don’t quite know what to do with 2023 yet.

During the last recession (2020), the manufacturers did better than the service providers.  The shutdown crushed those industries that relied on any kind of human interaction, and at the same time, there was a surge of stimulus designed to help get the economy out of the slide.  Unfortunately, the majority of this cash never made it into the economy as everything was shut down.  People turned to buying things rather than spending on travel, entertainment, and the like.  This was a boon to some manufacturers despite the supply chain breakdown.  Now there is the threat of a more “traditional” recession, and that would affect goods purchasing.  The hike in inflation has already affected low and middle-income consumers as they cannot really afford much discretionary spending these days.  Goods aimed at this income group will struggle to find markets, but the higher value goods are still in demand.

At the time of this writing, the markets were in turmoil again as they were back to expecting higher interest rates from the Fed.  The news regarding the economy has been better than expected, and that is not a good thing from an interest rate perspective.  The job market remains robust, business expansion is still in evidence, and confidence levels are recovering.  All this adds up to the Fed assuming it has room to move rates higher as it struggles to control inflation.  The pressure from factors such as commodity costs, logistics, and the like may have subsided, but the wage issue is taking the lead, and the worker shortage is making it extremely difficult to bring that wage inflation down.

Canada and Mexico

The Bank of Canada hiked rates to 4.5% but then declared it would stop at this level for a while.  The BoC has provided a fairly optimistic assessment for the year, although still asserting that inflation threats remain.  The expectation is that inflation will fall to 3.0% by the end of the year and 2.0% by 2024.  This is based on a couple of assumptions regarding employment, as there is a sense that reduced commodity prices will have an impact.  There is also some expectation that worker shortage will not be as big an issue for Canada as in the U.S.  This more optimistic assertion is based, to a degree, on the immigration approach taken.  Canada is getting a significant influx of immigrants from Ukraine of late, and these are often skilled and trained workers.  There is also an expectation that supply chain issues will continue to fade. 

Mexico is seeing a level of foreign direct investment that is unprecedented.  In the first nine months of 2022, it was up almost 30%.  Of that FDI, over 45% was brand new investment, and 44% was reinvestment.  The difference between 2021 and 2022 was dramatic.  It went from $7.3 billion to $32.1 billion.  This was part of what drove Q4 to grow by 3.7%, and that was much faster than either the U.S. or Canada for the same period.  The sense is that 2023 will be somewhat slower, however, that pace will be slowing down somewhat.  The Bank of Mexico sees a reduction in domestic demand and a reaction to a slowdown in the U.S., and predicts anemic growth of just 0.7% for the year.  If there is a rebound, it will have to come from increased commodity pricing and a recovery in the tourism sector.

Author profile: Dr. Christopher Kuehl (Ph.D.) is a Managing Director of Armada Corporate Intelligence and one of the co-founders of the company in 1999. He has been Armada’s economic analyst and has worked with a wide variety of private clients and professional associations in the last ten years. He is the Chief Economist for the National Association for Credit Management and is on the Board of Advisors for their global division – Finance, Credit and International Business. ν