Could the US avoid a recession in 2023? The case is gathering major steam. (2024)

• Inflation slowed in December, a good sign for the economy and cash-strapped consumers.
• While inflation is still high, a downward trajectory is good news for the Federal Reserve.
• Moderating inflation and a strong labor market may mean that no recession will come in 2023.

The US economy just proved it's making strides in combating sky-high inflation — and it means a recession this year could be avoided after all.

The Consumer Price Index, one measure of inflation, rose 6.5% year-over-year in December, which marked a big drop from the November reading of 7.1%. December is the sixth month in a row showing a decline in that figure, suggesting inflation has been cooling.

"Inflation is on its back heels," Mark Zandi, Moody's Analytics' chief economist, told Insider. That "broadly moderating" inflation should take pressure off the Fed for future rate hikes, he said — "and significantly raises the odds that the economy can navigate through without a recession in 2023."

Throughout 2022, the big question as Americans continued to battle high prices was whether the Federal Reserve would push the economy into an economic downturn. To slow economic growth and bring inflation down, the Fed hiked interest rates seven times during 2022, and its aggressive tactics had some economists and lawmakers concerned that the tightening could lead to job losses, and an eventual recession.

At the same time, the US labor market has looked at the possibility of a recession and essentially shrugged. Workers still feel comfortable leaving their jobs at near-record rates, and the layoff rate is still near the record low. The US added 223,000 payrolls in December, well above the 200,000 jobs forecast by economists Bloomberg surveyed — and the unemployment rate came down to 3.5%, below the 3.7% forecast. Although the US saw higher gains in the first few months of2022, the job growth in December still shows the labor market is hot.

Nick Bunker, economic research director at Indeed Hiring Lab, told Insider last Friday after the employment report that "the data that we have through the end of 2022 makes me feel more optimistic about 2023."

Data out Thursday also showed jobless claims declined, another indicator that mass layoffs have yet to emerge. Seasonally adjusted initial claims declined from 206,000 to 205,000 for the week ending January 7. And Thursday's report stated thatcontinuing unemployment claims for the week ending December 31 also fell to 1,634,000 from the previous week's 1,697,000.

Labor Secretary Marty Walsh previously told Insider that BLS's report on December payrolls ​​"contradicts all those conversations" about a recession.

Slowing inflation as measured by the CPI, robust nonfarm payroll gains, and other positive data points together may mean the US can avoid a recession.

Sinem Buber, lead economist at ZipRecruiter, said in a statement on Thursday that the latest CPI release "combined with recent labor market indicators, increases the likelihood of a soft landing,"referring to the commonly-used phrase describing a return to low inflation while maintaining a strong labor market and overall economy.

"Today's inflation numbers are good news, good news about our economy," President Joe Biden said during Thursday remarks. "We have more work to do, but we're on the right track. We're seeing bright spots across the country where great things are happening."

Inflation going down and employment going up are good signs — but it still all depends on the Fed

Goldman Sachs economists David Mericle and Alec Phillips also aren't so sure a recession is coming.

Mericle and Phillips wrote in a January 5 article that the firm estimated the probability of a recession this year is 35% due to its "optimistic view on whether a recession is necessary to tame inflation."

"We think that a continued period of below-potential growth can gradually rebalance supply and demand in the labor market and dampen wage and price pressures with a much more limited increase in the unemployment rate than historical relationships would suggest," Mericle said.

Of course, economic activity is reliant on the decisions the Fed will continue to make over the course of the year. In December, the nation's central bank raised interest rates 50 basis points, which marked a slowdown from its prior 75 basis point increases as CPI readings delivered promising results.

While December's Federal Open Market Committee (FOMC) meeting minutes noted that the Fed is not considering cutting interest rates this year, it's likely it could respond favorably to Thursday's CPI rating and continue to lower the pace of increases. Goldman's Mericle and Phillips expect the FOMC to announce 25 basis point hikesat their first three meetings of the year in February, March, and May — and then keep the rates level for the rest of 2023.

Zandi concurred on February and March hikes, but said it'll be a "a real debate whether they need to go anymore after that."

"My own view is that they don't need to," he said.

While Fed Chair Jerome Powell previously said "it's not knowable" whether there will be a recession this year, if the economy continues to deliver promising results, achieving the Fed's ultimate goal of a soft-landing — fighting inflation while avoiding a recession — just might be in the cards.

Regardless, the labor market will continue to cool, and the unemployment rate will still rise — which will be uncomfortable, Zandi said, but not a recession.

"It's gonna be a tough year," Zandi said, "but I think odds are increasingly likely that we can make our way through this year without a full blown outright economic downturn."