A changing of the guard at the highest level of state government means a potential change in headwinds for the 2023 economic forecast.
“You are going to have a Republican [in the] Governor’s Mansion, a super majority in the Assembly but not in the Senate, even though the Senate and Assembly are both Democrat controlled,” explained Cindy Creighton, president, Nevada Taxpayer’s Association (NTA). “What’s good for all taxpayers is, you have this divided government. Any time you have something like that, people are going to collaborate more, work together for the betterment of the citizens and the constituents.”
By November of last year the Federal Reserve (Fed) had raised interest rates six times and interest rates are entering 2023 at the highest since early 2008. Rates rose a total of 3.75 percentage points in 2022. These significant rate hikes are leading into the new year following historic lows when the Fed tried to stimulate the economy with very low interest rates and stimulus monies.
Raising interest rates is the way the Fed controls inflation. “We had a superheated economy for products and services, and the Fed said, ‘Listen, we need to cool things off, prices are increasing too fast.’ They measure price increases using the personal consumption expenditure (PCE) metric,” said John Restrepo, principal, RCG Economics. The PCE was coming in at 7 percent, well above the Fed’s target rate of 2 percent a year.
“Rising interest rates affect consumers as well,” explained Stephen Miller, director of research, Center for Business and Economic Research (CBER), Lee Business School. “Credit card debt becomes more expensive, so does auto loan debt and home mortgage debt. It affects everybody. It also affects the federal government, so higher interest rates mean that financing the national debt becomes more expensive, and that goes back to the taxpayer.”
Raising interest rates slows the economy and in turn, slows inflation. That’s a good thing. However, as Miller indicated, rising rates impact businesses and consumers; they can be good for the economy, but are hard on businesses. Economic activity slows, and companies stop buying goods and services because interest rates are too high. They stop borrowing money for inventory or investments because that creates too much debt.
“Less money in the market is really going to cramp the business startups and expansions who rely on that type of funding,” said Brian Bonnenfant, project manager, Center for Regional Studies, University of Nevada, Reno. “That’s the objective, to slow things down.”
The ripple effect of slowing demand for goods and services is the reduction in the number of employees businesses might need. Layoffs started last year, in high tech and other industries.
“That’s a little bit less of a concern right now because there’s such a labor shortage around the country,” said Restrepo. “But that is a concern over the longer term. If you don’t get inflation under control, it’s going to have a much bigger effect on the economy than rising interest rates.”
Household savings accumulated during the pandemic when the Fed pumped stimulus dollars into the economy and most people had nowhere to spend it. As a result, there is currently the most household wealth in consumer bank accounts since the 1950s.
“Now we’re spending it like drunken sailors on shore leave,” said Bonnenfant. “But as the debt piles up and the savings dissipate, we’re going to see pullback from the consumer.”
But with rising interest rates, rising inflation and the start of layoffs, unemployment isn’t just anticipated to increase—it’s being manipulated. “The Fed is trying to do two things at one time that are kind of contradictory,” explained Restrepo. “They’re trying to slow down price increases, cool off demand, without the unemployment rate going up too high.”
Consumer spending is still strong. But rising interest rates creeping into mortgage lending and credit card debt is beginning to balance out the overheated economy.
As interest rates and inflation eat steadily into consumer savings, there’s been discussion that the Fed is targeting a 5 percent unemployment rate. Forcing debts up and creating a higher unemployment rate cools consumer spending. It also hurts businesses that have inventory they can’t move, and either stops them from borrowing, or forces them to borrow at high rates for capital expansions.
“All of this has been artificially induced from the get-go,” said Bonnenfant. “From the closing of the economy, which is what put us in this position. All of this has been artificial movement by government policies and decision making.”
The “R-Word”
“Unlike the Great Recession, and unlike the pandemic recession, this is more of a normal event,” said Miller of the dreaded “R-Word” – Recession. Normal means the economy starts overheating, the Fed raises interest rates, the economy slows. One signal of an overheating economy is inflation picking up. Another is low unemployment, like 2022’s historically low 3.7 percent. “That’s good news for the Fed, because the Fed is raising interest rates trying to slacken demand, to reduce the inflation rate. The fact that the labor market is still very strong allows them to continue putting the brake on the economy to try and get inflation down,” said Miller.
No one knows yet if inflation will fall fast enough to ease off the brakes without falling into recession. That’s the difference between a soft landing, or a slowdown, and a hard landing, or a recession. “Analysts are all over the place on this,” said Miller. At CBER’s Outlook 2022 conference, the forecast was for a slow economy but no recession in the next two years. Businesses are expected to pull back on spending in the new year, leading to some type of mild downturn.
“Business [owners] say, ‘Wait a minute, they’re increasing interest rates again, what are the Feds going to do in 2023? Are they going to increase interest rates again or leave the interest rates at a certain level—they call it the terminal rate—and see what happens,’” said Restrepo.
The Fed is less interested in controlling short-term effects of inflation, like the cyclical rise and fall of energy and food prices, which can change quickly. It’s long-term inflation they’re looking at. What’s the inflation rate going to be in five years?
“Currently the expectation is around 2 to 2.5 percent, not very high and not far from the Fed’s target inflation. That gives them some comfort to know [that], at least the private sector has not incorporated rising inflation expectations. If people expect high inflation, it will affect their behavior in a way that will be self-fulfilling prophecy,” said Miller. If consumers expect high inflation, and are considering a purchase in the future, that purchase might be moved up to take advantage of current prices rather than waiting for higher prices. That, in turn, drives demand sooner rather than later, and drives prices up sooner rather than later. Entrenched inflation makes it harder to slow the economy.
Miller expects a pause in rate hikes in late 2023, and the next move will depend on the economy’s reaction. If inflation is going down, interest rates should start to move down. If it’s sticking, they might increase again.
Taxes
It’s hard to pinpoint yet what Nevada taxpayers can expect in 2023, and how possible changes to taxes may affect the economy and Nevada businesses. Both the Governor and Governor-elect said, “No new taxes,” when on the campaign trail.
Which doesn’t mean there aren’t issues that need to be solved and revenue that needs to be collected. Creighton points to Nevada’s fuel tax, decreasing in response to electric and fuel-efficient vehicles. Both are good for the environment, but there’s a need for fuel taxes to support road maintenance, state and local governments, and Nevada Department of Transportation.
Colorado tackled loss of fuel tax dollars with a parcel delivery fee of $0.27 per box. The move is controversial, and there’s no sign of anything similar in Nevada bill drafts, but it’s something to watch, Creighton said. Something else worth watching is the difference between fee and tax. Maybe there are no new taxes, but new fees also come out of taxpayer pockets.
The state will also need to find a solution to programs that were created during the pandemic from Federal funding. “Now that those aren’t there anymore, do we let the programs go away? Or are they necessary, like some of the mental health positions that were created?” asked Creighton.
Real Estate
“Real estate is in recession,” said Miller. Housing prices are falling dramatically. The forecast is for double digit price declines over the next few years, conditional on the Fed continuing to raise interest rates and mortgage rates rising.
“It’s not a collapse like we saw just before the Great Recession, but [house prices are headed] in a significant direction. Before the most recent house price declines, prices were going up in double digit rates,” said Miller.
“We’re not on fire like we were [at the] end of 2020 through 2021 or even the beginning of 2022,” said Tom Blanchard, president, Nevada Realtors. “Back then everybody was saying how overstimulated the market was and how we had to get back to a more normal market where buyers can find homes and not have to overbid and overpay.”
That was the point at which interest rates went up. Today the market is more normal. Buyers aren’t paying $30 to $50,000 above listing price. “Everybody is getting more of a fair deal when purchasing a property right now,” said Blanchard. The market is in transition from overstimulated with low interest rates to interest rates likely to fluctuate between 5 and 8 percent. “Which is still lower than the 10 percent we had before,” he added.
Basically, it’s a normal market. But for buyers accustomed to the low 2 percent interest rates, the current rate seems unfathomable.
“I’d say 2023 is going to be that year of people adjusting in their minds that they’re going to not be able to afford the $450,000 or $500,000 home, but the $400,000 home,” said Blanchard. He added that he expects by 2024 the market should be seeing increased equity and a normal market.
Commercial real estate is facing uncertainties in the changing market, but economic indicators for southern Nevada show the industry may not be as impacted as the rest of the country.
“There’s an increase in demand across all property lines except multifamily, which is a little weaker than some of the averages,” said Natalie Allred, president-elect, Commercial Alliance Las Vegas (CALV). “Some economists think we’ve reached the peak of our ‘recession.’ For Las Vegas, despite the slight decline, I don’t think it’s going to be as heavy as for other areas.”
Interest rate hikes have increased the cost to borrow, Allred said, and the market is trying to navigate it. “Capital markets over history have tended to fare okay in this type of economic situation,” she added. But there are still uncertainties facing the market, like staff shortages, and pandemic-caused supply chain issues no one’s ever had to navigate before.
Inflation drives up new development construction costs. Tenant rental rates are fixed at 3 percent annual increases, as a general rule of thumb, Allred said. When looking at 8 to 9 percent inflation costs, it’s not possible to keep up with that.
In 2023, Allred expects retail and office to do well. Industrial, she explained, is another matter. The industrial industry may be in flux, “just from the aspect of a lot of tech industries and layoffs that may impact the big Amazons of the world, the largest industrial users,” Allred said.
Sneak Peek: What to Know For 2023
If it takes time for raising interest rates to affect inflation, then there’s lag time between interest rates going up and businesses and consumers seeing relief from inflation. Bonnenfant said bankers expect rates to be below 3 percent by end of the year. The Feds–the ones setting the rates–are looking at two years.
When rates drop, prices will drop, and hopefully product-makers will pass along savings to businesses and consumers. “Business owners are going to start seeing relief when they can purchase goods and services at a lesser price once inflation comes down,” said Bonnenfant.
In the meantime, “As the old saying goes, ‘You can never go broke having too much cash,’” said Restrepo. Business owners should prioritize cash in the bank, manage cash flows and expenses, and keep expense to revenue ratio within an acceptable range.
“You’re planning for a rainy day,” said Restrepo. It’s just not clear yet if that’s a drizzle or a thunderstorm. The consensus of economists is there’s an economic downturn or adjustment coming. Businesses with variable rate credit lines will find costs going up. Those with outstanding fixed-rate credit shouldn’t be in any hurry to pay that off—it would just be replaced with higher interest rate debt.
Business owners should also watch the unemployment rate, “because if they see the unemployment rate going up, they’ll know a recession could be right around the corner,” said Miller.
For businesses with room to stock up on inventory, getting it now at lower interest rates is better than waiting, said Miller, but it does drive up demand now, making it harder for inflationary rates to back off.
Plan for the worst-case scenario, said Bonnenfant. If inflation becomes embedded and isn’t controlled, there will be layoffs. Business plans should be revised to create a buffer against stagflation and against continued high energy costs if the war in Ukraine continues. If capital improvement projects can be postponed, they probably should be.
There’s still ARPA funds (American Rescue Plan Act) available from the state. Nevada has a $150 million small business grant to distribute. In October, a $1.8 million StartUpNV grant was announced. The Office of Small Business Advocacy launched in 2022.
The Nevada Legislature will meet in the spring of 2023, setting the new budget for the next two years. Bonnenfant suggests tracking the monies in the final budget. Where they’re allocated indicates industries expected to perform well.
Industry Strong
Industries forecasting a strong 2023 include rare earth minerals as Nevada sets its sights on lithium mining and the electric vehicle and battery industries.
The auto industry itself is cooling off as gas prices remain high, though the energy industry could have a strong year. Gold mining usually does well as a safety net in a downturned economy.
“Renewable energy will be good for Nevada because a lot of these international industries that come into our business parks have some kind of environmental social governance policy that heavily push renewable energy,” said Bonnenfant.
Healthcare and hospital construction should remain strong. Industrial construction reports 2023 will be a strong year.
Education and Economy
Under the new education funding formula implemented during the last fiscal year, the state education fund will get to keep any higher-than-expected revenues. Previously, even when the economy was strong the state hadn’t been funding education at the pace of economic growth, according to Dr. Susan Enfield, superintendent, Washoe County School District.
“There’s hope that under this new funding formula we have the potential to increase our funding and address what is a pretty significant compensation challenge that every school district in the state of Nevada is facing,” said Enfield.
Rising interest rates affect school district funding. Rainy day accounts earn more interest when rates rise. However, when the district builds new schools and issues long-term debt bonds to cover costs, if interest rates increase, debt reissue is at a higher rate and the district pays more interest. The economics of education will remain a balancing act in 2023.
Primary funding for education is based on tax revenues. Information from the Nevada Economic Forum, which provides forecasts for the state’s General Fund revenues, should show the impact of the state’s budget on education. “Hopefully, as we continue to see revenues going up, especially in gaming, we should see an increase in state funding for education,” said Dr. Jesus Jara, superintendent, Clark County School District (CCSD).
As interest rates rise, the cost of raising capital through bonds increases. “We spend more money on interest rates than we do on our building and infrastructure,” said Jara. “It’s a challenge, and we have such a huge need in our capital improvement. Obviously, our funding won’t go as far as it needs to in our capital infrastructure.” CCSD has a $3.4 billion bond for 10 years to build 13 new schools and fully renovate another 13. “But we also have a $6 billion need in aging, in construction, in facilities that need [renovation],” said Jara.
“What does it mean to be a sustainable economy over the long term?” asked Restrepo. “That’s becoming a bigger and bigger topic of conversation. There’s a general consensus, and data to support it, that the resort industry in southern Nevada will still be a vibrant industry but it’s not going to be as big of a major employer as it used to, before the pandemic.”
As the resort industry uses more technology, it becomes a smaller employer, and there are questions asked about how Nevada can retain resiliency as thriving western metros.
“Remember the old term in use 10 to 15 years ago, ‘smart growth’? It’s kind of a cliche, but it’s starting to mean something,” said Restrepo.
What is smart growth? Restrepo explained, “How do you have an economy that provides a decent way of life for its residents and also protects the environment and is sustainable and continues to grow at a certain rate? Maybe it’s not about high growth anymore. There’s a difference between economic development and economic growth. Economic development has a growth component to it, but it doesn’t mean high levels of growth. Maybe the era of hyper growth is over in Nevada, and maybe that’s not a bad thing.”
