Moody's warns of 'slowcession' that could last throughout 2023

Moody's Analytics warned in a new report that the U.S. could face what it called a "slowcession" this year but maintained that the economy will most likely avoid a full-blown downturn.

"Under almost any scenario, the economy is set to have a difficult 2023," Moody's chief economist Mark Zandi said in the January report. "But inflation is quickly moderating, and the economy's fundamentals are sound. With a bit of luck and some reasonably deft policymaking by the Fed, the economy should avoid an outright downturn."

Fears of a looming recession have been pervasive throughout the last year, as inflation skyrocketed and the Federal Reserve raised interest rates in an effort to rein in the rising prices.

Two-thirds of economists at 23 major financial institutions predicted that a recession would occur this year, according to a recent survey from the Wall Street Journal.

However, Zandi warned that such recession pessimism could be self-fulfilling.

"Recessions are ultimately a loss of faith — a loss of faith by consumers that they will hold on to their jobs, causing them to curtail their spending, and a loss of faith by businesses that they will be able to sell what they produce, causing them to lay off workers," he said. "A self-reinforcing vicious cycle — a recession — takes hold."

Despite recession concerns, there have been positive indicators in recent months, as inflation has continued to slow after reaching 40-year highs last year. The annual inflation rate for November came in at 7.1 percent, down from 7.7 percent in October.

Although that is still much higher than normal, the improving outlook allowed the Federal Reserve to limit its interest rate hike to 0.5 points last month, following four straight increases of 0.75 points.

The economy also has "generally solid fundamentals," which could help it avoid a recession, Zandi noted.

"Typically, prior to recessions, the economy is plagued by significant imbalances such as overleveraged households and businesses, speculative asset markets, an undercapitalized financial system that has extended too much credit, overbuilt real estate markets, or financially stretched state and local governments," he said. "For the most part none of these imbalances exist today."

The most significant threat to the economy is a potential misstep in policy by the Federal Reserve, Zandi said. If the Federal Reserve were to increase interest rates higher than necessary in an effort to continue to bring down inflation, it could push the economy into a recession, he added.

However, "the baseline outlook holds that the Fed will be able to accomplish this without precipitating a recession," Zandi said.