The first few months will be challenging, but things will look up for investors later in the year.

Last year was a wild ride for the economy and global financial markets: record-high inflation, rising interest rates, and slowing consumer and business spending.

What will 2023 hold? Eric Freedman, chief investment officer at U.S. Bank, expects a choppy start to the year, followed by more favorable conditions for investors. Here are three key things to know.

1. Interest-rate hikes won’t end anytime soon

In 2022, the Federal Reserve (the Fed) raised interest rates six times, and we expect that they’ll continue to raise them for the next three to four months. There are several reasons for that:

• Inflation remains elevated
• The job market is very strong
• We feel Wall Street’s estimates for company earnings are too optimistic at the moment
   

The Fed is trying to cool the economy with interest-rate increases, but these increases have a delayed impact. They’re aiming for a “soft landing” – slowing the economy without widespread housing market pain, business bankruptcies or high unemployment – but the priority for the Fed right now is curbing inflationary pressures.
 

General economic activity appears to be slowing down:

• People are spending less as higher costs for food, heating, transportation and housing takes a bite out of their paychecks
• Businesses may already be preparing for slowing consumer spending by limiting plans for expansion
   

The Fed is aiming for an annualized inflation rate of 2%. Once they feel the economy has slowed enough to scale back inflation, interest-rate hikes should come to an end. That will create a more favorable environment for investing in the second half of the year.

2. Consumers can’t endure price hikes forever

The pandemic created the perfect storm for inflation. COVID-19 created major supply-chain issues and shortages, which drove prices up. At the same time, people received several rounds of stimulus payments, which many spent on a now limited supply of goods.

On top of that, Russia’s invasion of Ukraine drove up prices for energy (natural gas and oil) and food. And, as the economy recovered, the job market surged. We now have more jobs than people to do them, leading to higher wages.

We like to say that the U.S. consumer is like a runner with an ankle injury. Consumers can endure some price increases – gasoline prices, food costs, increased rent, higher mortgage payments on new homes, airline tickets and lodging costs – but the longer those price increases remain sticky, which we think they will, the more of an impact it will have.

Savings rates have already dropped to historic lows, and demand for credit is high as people spend money on experiences like travel and inflation takes a bite. In addition, interest-rate hikes have made borrowing money for a house or a car (for consumers) or to buy new equipment or expand (for businesses) more expensive. If the economy continues to slow – should companies lay off workers or inflation continues to rise, for example – spending could slow even more, and we think inflationary pressures will subside.

3. There are places to invest: now and in the future

Right now, we’re recommending investments in select sectors and industries including utilities, infrastructure and energy companies. These defensive-oriented, dividend-paying equities were among the best-performing companies in 2022, and we think that will continue into 2023.

We also believe that high-quality, short-term bonds will deliver favorable returns in 2023. Treasuries offer attractive income, and opportunities in long-term Treasury bonds could improve as interest rates peak and the economy slows.

Want more details? Read our interview with Eric Freedman or take a deeper dive into the markets and economy in our 2023 investment outlook.