National Economy Heats up While the State Economy Slows Down
Looking back to our first issue in late 2022, we saw the national and state economies gaining strength and confidence, though the heady days of 2021 were unlikely to return soon. The newest data from the Bureau of Economic Analysis show that the national economy continued on the same path and the nation enjoyed strong growth in the fourth quarter. South Dakota, on the other hand, did not fare so well.
At the national level, the first two quarters of 2022 saw declines in real output, with growth coming in at -1.6% in the first quarter and -0.6% in the second. In contrast, Q3 posted a sharp reversal, and annualized growth in the third quarter was 3.2%. The latest Q4 GDP estimates were equally as strong, and BEA estimated that real GDP growth in the fourth quarter was 2.6%, which put overall real growth at 2.1% for the year.
South Dakota, in contrast, started the year strong, posting 1.7% real GDP growth in the first quarter. Rising inflation and national headwinds began to show their effects starting in the second quarter, though, and real growth slowed to -1.7% in Q2 and -0.5% in Q3. Growth seemed likely to return in the fourth quarter, but the latest BEA estimates have fourth-quarter growth at -4.3%. BEA may revise this estimate upward in later releases, but for now, the data show a marked slowdown in economic activity during the fourth quarter. Several severe winter storms in November and December likely contributed to this slowdown, but the data do not offer any clear causes at this time.
At the national level, growth in the second half of 2022 was unexpectedly robust. Lingering inflation, rising interest rates, and concerns about financial stability may yet slow the economy, but the prospects for a soft landing are looking better than they did a year ago. Unsurprisingly, the weather will likely be a determinative factor in South Dakota’s economic performance. Difficult winter conditions in January and February could depress activity in the first quarter, and wet fields could prevent farmers from getting crops into the ground, which would be another hit for the state economy. On the other side of the ledger, the sales tax cut, which goes into effect on July 1, could stimulate the economy. The magnitude of any tax effects is unknown, though. At this time, we are maintaining our 2023 growth forecasts and will monitor the above factors through the first half of the year for developments that could alter the forecast.
Turning to the inflation picture, year-end inflation rates paint an unpleasant picture, but the quarterly trends indicate inflation pressures were moving in the right direction. As measured by the CPI, prices rose by an average of 8.0% in 2022, even though CPI inflation in the fourth quarter had slowed to 6.9%. Core inflation (CPI less food and energy) finished the year even lower at 6.2%, once again higher than at any time since 1982. The inflation trend was moving in the right direction, though, and Core CPI inflation was down to 5.8% in the fourth quarter. Consequently, inflation rates will likely continue edging lower given the FED’s vocal commitment to raising rates until inflation falls to more acceptable levels, officially 2% in the FED’s public messaging.
In demonstration of its commitment, the FED continued to raise rates throughout 2022, and the FED’s target rate closed the year at 4.5%. As expected, the FED has continued to raise rates in early 2023, raising its FED Funds target rate to 5.0% in March. Of note, the FED did not pause its pattern of rate increases even in the face of financial instability resulting from two high-profile bank failures. As a result, we expect the FED to continue on this path, at least through the first half of the year, when we see the potential for a small rate cut during the fourth quarter.
Mortgage rates rose considerably throughout 2022, rising from 3.5% in January 2022 to a peak of 7.1% in October before falling slightly to 6.4% by the end of the fourth quarter. The average 30-year mortgage rate for 2022 was 5.5% as a result, and we expect the average for 2023 to end up around 5.8%, only slightly higher than in 2022. FED rate increases will continue to press rates upward, but the slowing housing market will push rates in the opposite direction as consumer housing demand is expected to remain muted. The net effect of these two forces, among others, is unknown, but we do not expect rates to rise or fall much more than a point in either direction during 2023.