December 20, 2023

Americans emerged from the pandemic with a desire to spend, and REIN contacts across the Southeast reported record-breaking earnings and struggles with keeping goods on their shelves.

As 2023 ends, the Regional Economic Information Network (REIN) looks in the rearview mirror. While 2022 was marked by labor shortages, roaring demand, lack of supply, and high inflation, 2023 saw a robust economy and continuation of many of these trends, but less severe than in the previous two years. Supply and demand moved closer together and many business contacts noted a moderation or "normalization" in demand.

Demand: Return to normalization

The previous two years saw robust consumer demand. Americans emerged from the pandemic with a desire to spend, and spend they did. REIN contacts across the Southeast reported record-breaking earnings and struggles with keeping goods on their shelves. Demand remained strong in 2023 but moderated somewhat in comparison to the previous years. Throughout the year, contacts reported a consistent story: demand is slowing in a measured way within and across many industries but at a pace that is not concerning for most firms. Contacts categorized this as a "normalization," recognizing that previous two years' growth was not sustainable. This slowing in demand was particularly notable in consumers' discretionary spending. Some retailers reported customers trading down or shopping for better prices, a phenomenon especially pronounced among low- to moderate-income customers.

While many firms have reported some moderation in demand, there are differences across sectors. Real estate (residential and commercial), a sector particularly sensitive to interest rates, saw a marked pullback in demand. Real estate contacts noted slowing market conditions for single family, multifamily, hotel, office, and industrial properties, a trend supported by public reporting and data. Sluggishness in the office segment of commercial real estate (CRE) is expected to linger into 2024 and beyond.

Growth in demand remains robust for some pockets of the economy, particularly areas such as infrastructure that are supported by government spending. On the whole, overall demand in 2023 edged in the direction of normalizing to more sustainable, prepandemic levels.

Labor: Market tightness and wage pressures ease

In early 2023, reports on labor market conditions were similar to those from 2021 and 2022. Contacts indicated that the labor market remained tight, particularly for skilled positions. Wage growth remained robust and above normal year-over-year levels as employers struggled to attract and retain workers.

As the year progressed, contacts noted a continuous easing of labor market tightness 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 demand for output softened, leading to a broadened easing of conditions for more firms, industries, and roles. A majority of contacts reported that it was easier to hire and retain workers. In some cases, firms had over-hired and looked to reduce headcount as demand slowed. This rightsizing was generally done through attrition, although a minority of contacts did report layoffs. Some contacts experimented with ways to save on labor and compel attrition, such as reducing hours or instituting pay freezes. Hiring remains particularly difficult in some areas, such as health care, or for roles requiring 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. In addition, many contacts noted that they did not need to enact multiple off-cycle wage increases in 2023, as they had 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 trailing supply. Supply chain disruptions brought on by shutdowns during the pandemic lingered as manufactures tried to get through backlogs of orders, and ports remained congested. Meanwhile, demand was strong as consumers had money to spend. As demand outpaced supply, inflation persisted. This led the Fed to aggressively raise interest rates, starting in the first half of 2022, to try to bring inflation under control. Toward the end of 2022, supply chains began to loosen, and contacts reported shorter lead times and greater availability of goods, slowing inflation as the gap between supply and demand narrowed.

Early in 2023, firms were reporting that growth rates of input cost had begun to moderate, largely attributable to improvements in supply chains. In most cases, these slowing costs were not passed through to customers and many firms continued to aggressively raise prices, maintaining historically high margins amid high demand. However, increased price sensitivity in the consumer goods area, particularly among discretionary spending for lower-income households, was reported.

In the second quarter of 2023, most firms reported more notable declines in growth rates of their total operating costs. In particular, freight and container costs declined significantly, affecting costs of obtaining goods. Customer price sensitivity was broadening, causing many firms to slow the pace at which they increased prices. Price sensitivity was more readily apparent in the business-to-business space through contract negotiation, but also spread into the consumer space. As costs and pricing power declined, many firms experienced changes in margins, but even they generally reported that margins remained higher than prepandemic 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, easing of inflation continues on the goods side and now increasingly permeates the services sector. While price growth persists for many firms, it is generally at a much slower rate, and some have discontinued price increases or even lowered prices. Many consumer-facing businesses are using discounting 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 elevated. As many firms see their pricing power wane, they also see slowing growth of operating costs, enabling many to maintain margins. A major exception is insurance, where price increases remain extremely elevated, leading some firms to not fully insure or to delay or cancel projects because of the high cost.

Credit: Lenders take more conservative approach

At the beginning of 2023, financial institutions reported calm in the lending market. There were early signs of softening in consumer finance, but delinquencies and past dues remained below pre-pandemic levels.

On March 10, 2023, Silicon Valley Bank (SVB) failed suddenly, following a run. This failure caused waves in the banking sector and in the broader economy. Immediately following SVB's collapse, there was a general concern that more failures might be imminent. While a couple of small failures followed, most financial institutions remained resilient.

However, concerns around bank stability led regulators and bankers to take a more conservative approach to lending, slowing lending in high-risk sectors, implementing higher underwriting standards for loans, etc. At the same time, the Fed rapidly raised interest rates to combat inflation, making borrowing less attractive.

The pullback in lending that became more pronounced following SVB's failure limited many firms' ability to invest in new projects since they were less likely to get approved for loans, which cost more with stricter lending practices and higher interest rates. However, some firms that could not get approved or could not afford to get loans from banks turned to alternative lenders, particularly private equity, to finance projects.

As the year progressed, the Fed continued to raise interest rates, making loans more expensive, and banks remained conservative in granting loans amid rising uncertainty in the economy. Particularly in struggling sectors, such as CRE, banks did not grant any loans.

In recent months, we have seen pullback in alternative lending and private equity, and many private investors are increasingly cautious amid concerns about a slowing economy. In the current lending environment, most firms spending money are using cash, and those who do not have cash on hand are spending very little.

While defaults are not currently a large problem, many bankers are expressing concerns about commercial loans that will come up for refinancing in the next few years. Some report actively working with borrowers who may struggle to pay upon renewal to derive a plan to avoid default.

Looking ahead: Signs point to continued normalization

As we approach 2024, many signs point to a continued measured slowing or normalization of economic activity. Uncertainty and risks always remain—commercial debt coming due and geopolitical events, for example— but we will continue to closely monitor economic trends in the new year.

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Roisin McCord

Director, Regional Economic Information Network

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Justin Shadley

Senior Business Analyst, Regional Economic Information Network