Americans emerged from the pandemic eager to spend, and REIN contacts across the Southeast reported record profits and struggled to keep products on their shelves.
As 2023 ends, the Regional Economic Information Network (REIN) looks in the rearview mirror. While 2022 was marked by labor shortages, rising demand, lack of supply and high inflation, 2023 saw a robust economy and the continuation of many of these trends, but less severe than in the previous two years. Supply and demand came closer together and many business contacts noted a moderation or "normalization" of demand.
Demand: return to normalization
The previous two years saw strong consumer demand. Americans came out of the pandemic wanting to spend, and they spent. REIN contacts across the Southeast reported record profits and are struggling to keep products on their shelves. Demand remained strong in 2023, but moderated somewhat compared to previous years. Throughout the year, contacts reported a consistent story: Demand is slowing measuredly within and across many industries, but at a pace that is not concerning for most companies. Contacts categorized this as a โnormalization,โ recognizing that the growth of the previous two years was not sustainable. This slowdown in demand was particularly notable in consumer discretionary spending. Some retailers reported that customers were lowering their prices or shopping for better prices, a phenomenon especially pronounced among low- and moderate-income customers.
While many companies have reported some moderation in demand, there are differences between sectors. The real estate sector (residential and commercial), particularly sensitive to interest rates, experienced a marked decline in demand. Real estate contacts noted a slowdown in market conditions for single-family, multifamily, hotel, office and industrial properties, a trend supported by public reports and data. The slowdown in the commercial real estate (CRE) office segment is expected to extend into 2024 and beyond.
Demand growth remains strong in some sectors of the economy, particularly in areas such as infrastructure that are supported by public spending. Overall, overall demand in 2023 moved toward normalizing to more sustainable pre-pandemic levels.
Work: Market tension and wage pressures ease
As of early 2023, reports on labor market conditions were similar to those in 2021 and 2022. Contacts indicated that the labor market remained tight, particularly for skilled positions. Wage growth remained strong and above normal levels year after year as employers struggled to attract and retain workers.
As the year progressed, contacts noted a continued easing of labor market tension and wage pressure. REIN contacts increasingly commented that by the second half of 2023 labor market dynamics had begun to stabilize as the supply of workers improved and production demand softened, leading to further easing of conditions. for more companies, industries and roles. Most contacts reported that it was easier to recruit and retain workers. In some cases, companies had overhired and sought to reduce their workforce as demand slowed. This adjustment was generally made through attrition, although a minority of contacts reported layoffs. Some contacts experimented with ways to save on labor and force attrition, such as reducing hours or instituting wage freezes. Hiring remains particularly difficult in some areas, such as healthcare, or for roles that require specialized skills.
Amid greater labor availability, wage increases in 2023 were generally lower than in 2022 and are expected to be even lower in 2024. Additionally, many contacts noted that they did not need to enact multiple off-cycle wage increases in 2023, as they had done. in previous years, often allowing them to meet labor budgets.
Costs and prices: Growth rates begin to moderate
As 2023 began, inflation was still elevated, but lower than it had been for most of 2022. Plagued by the highest inflation in several decades, 2022 saw strong demand and lagging supply. Supply chain disruptions caused by shutdowns during the pandemic persisted as manufacturers tried to overcome backlogs of orders and ports remained congested. Meanwhile, demand was strong as consumers had money to spend. As demand outstripped supply, inflation persisted. This led the Federal Reserve to aggressively raise interest rates, starting in the first half of 2022, to try to control inflation. Towards the end of 2022, supply chains began to relax and contacts reported shorter delivery times and greater availability of goods, slowing inflation as the gap between supply and demand narrowed.
By early 2023, companies were reporting that input cost growth rates had begun to moderate, largely attributable to improvements in supply chains. In most cases, this cost slowdown was not passed on to customers and many companies continued to aggressively raise prices, maintaining historically high margins amid high demand. However, greater price sensitivity was reported in the area of โโconsumer goods, particularly among discretionary spending by low-income households.
In the second quarter of 2023, most companies reported more notable declines in the growth rates of their total operating costs. In particular, freight and container costs decreased significantly, which affected the costs of sourcing goods. Customers' price sensitivity was widening, causing many companies to slow the pace at which prices increased. Price sensitivity was most evident in the business-to-business space through contract negotiation, but it also extended to the consumer space. As costs and pricing power declined, many companies experienced margin shifts, but even they generally reported margins remaining higher than pre-pandemic levels. While inflation slowed substantially on the goods side of the economy, services inflation remained elevated, a trend that continued throughout the quarter.
Throughout the second half of 2023, inflation moderation continues on the goods side and now increasingly permeates the services sector. While price growth persists for many companies, it is generally at a much slower pace and some have paused price increases or even reduced them. Many consumer-facing companies are using discounts and promotions for the first time in years.
However, in some areas that continue to see particularly strong demand, such as infrastructure, price growth remains high. As many companies see their pricing power decline, they also see operating cost growth slow, allowing many to maintain margins. A major exception is insurance, where price increases remain extremely high, leading some companies to not fully insure or to delay or cancel projects due to high cost.
Credit: Lenders take a more conservative approach
In early 2023, financial institutions reported calm in the credit market. There were early signs of weakening in consumer financing, but delinquencies and overdue debts remained below pre-pandemic levels.
On March 10, 2023, Silicon Valley Bank (SVB) suddenly failed after a run. This failure caused waves in the banking sector and the economy in general. In the immediate aftermath of SVB's collapse, there was widespread concern that more failures could be imminent. While there were a couple of small bankruptcies, most financial institutions remained resilient.
However, concerns around banking stability led regulators and bankers to take a more conservative approach to lending, slowing down lending in high-risk sectors, implementing stricter underwriting standards for loans, etc. At the same time, the Federal Reserve rapidly raised interest rates to combat inflation. , which makes debt less attractive.
The reduction in lending that became more pronounced after SVB's bankruptcy limited the ability of many companies to invest in new projects as they were less likely to be approved for loans, which cost more with stricter lending practices and interest rates. higher. However, some companies that could not get approval or could not afford to borrow from banks turned to alternative lenders, particularly private equity, to finance projects.
As the year progressed, the Federal Reserve continued to raise interest rates, making borrowing more expensive, and banks remained conservative in lending amid growing uncertainty in the economy. Especially in distressed sectors, such as CRE, banks did not grant any loans.
In recent months, we have seen a pullback in alternative lending and private equity, and many private investors are increasingly cautious amid concerns about a slowdown in the economy. In today's credit environment, most companies that spend money use cash, and those that don't have cash on hand spend very little.
While defaults are not currently a big problem, many bankers are expressing concerns about commercial loans being refinanced in the coming years. Some report actively working with borrowers who may be struggling to pay at renewal to come up with a plan to avoid default.
Looking ahead: signs point to continued normalization
As we approach 2024, many signs point to a continued measured slowdown or normalization of economic activity. Uncertainty and risks always remain (overdue trade debt and geopolitical events, for example), but we will continue to closely monitor economic trends in the new year.
