The question that obsessed financial markets last year was when and where U.S. inflation would peak. The 2023 version will likely be how far, and how fast, it comes down.

Economists may not see eye-to-eye on the answer – but they more or less agree about where to look for it.

The path of inflation will be determined in a handful of crucial areas of the economy. Some are domestic – what happens in American labor and housing markets will be key – and others are global as supply chains get reconfigured and trading blocs are reshuffled amid great-power tensions.

U.S. inflation is already retreating from a four-decade high above 9 percent. The December consumer price index, due on Thursday, is forecast to show a year-end rate of 6.5 percent. Pretty much everyone has a huge stake in where it’s headed next.

Millions of households need respite from the cost-of-living squeeze. The Federal Reserve has to figure out how much further to go with interest-rate hikes that already threaten to cause a recession – and, eventually, when to reverse them. Trillions of dollars in financial assets hinge on the outcome.

Following is a look at where the next phase of the fight against inflation will be won or lost.

THE RECESSION FACTOR

It’s a bedrock truth of economics that slower demand usually means less inflation, as consumers dial back the spending that helps push prices up. That’s the expected backdrop in 2023. Economists surveyed by Bloomberg expect a U.S. recession.

A cooled-down economy is what the Fed wants to tame inflation – and the full impact of its monetary tightening last year is yet to be felt.

For now, the economy looks like it’s growing at a healthy clip, with few signs that American consumers are hunkering down. That’s partly because plenty of them can still draw from a stash of pandemic savings – and above all, because so many of them have jobs and are getting wage raises.

WATCHING PAYCHECKS

Unemployment ended last year matching a five-decade low. Labor is scarce, forcing companies to dole out higher pay to attract employees. Some wage measures suggest that workers, after playing catch-up for months with the cost of living, now have a chance to get ahead of it.

That risks propping up inflation as the income growth boosts spending power and companies with higher wage bills consider price hikes to preserve margins.

The momentum “in energy, food and goods prices is in the direction of lower inflation,” says Michael Gapen, head of U.S. economics at Bank of America. “You’d have to conclude that if there’s an upside miss, it’s because the labor market stayed stronger.”

Fed chief Jerome Powell says he’s focused on one inflation gauge that’s closely linked to pay levels. It measures the price of services other than energy and housing – everything from medical treatment, which looms large in inflation calculations because it’s one of the biggest costs for households, to haircuts. In those industries, wage bills make up a large chunk of business outlays.

Still there are reasons to think a wage-price spiral like the one that triggered sky-high inflation in the 1970s won’t happen this time. December’s jobs report showed wage-growth cooling. U.S. businesses have posted record profits since COVID hit, giving them room to hike pay without raising prices.

And the economy’s productivity will be key, because if that improves, there’s more space for pay raises that aren’t inflationary. The pandemic-era productivity numbers haven’t been great, but some analysts say innovations like remote work and automation will deliver bigger benefits down the road.

SUPPLY CHAINS AND GREAT-POWER COMPETITION

A key driver of pandemic inflation was the breakdown of global logistics networks. Now, as supply chains return to normal, shipping costs are dropping and delivery times are improving.

That’s why goods prices are poised to lead inflation lower. It’s already happening in some categories – like used cars, for example, which soared as the COVID-related supply crunch in semiconductors curtailed new-vehicle manufacturing. But there are still risks to global trade flows, especially from the war in Ukraine and the strained U.S. relationship with China.

In the auto industry, for example, “it wouldn’t take much on the geopolitical front to throw a wrench into an important supply chain and therefore keep new auto production stymied,” says BofA’s Gapen.

GEOPOLITICS REMAINS A THREAT IN COMMODITY MARKETS

Russia’s war against Ukraine, coming on top of the COVID crisis, helped drive a big spike in global energy and food prices. Both have since pulled back from their post-invasion peaks, and the decline will help push inflation down this year.

With the war still raging and the world economy fragmenting into rival blocs, it’s hard to rule out more turmoil. Credit Suisse analyst Zoltan Pozsar reckons inflation forecasters aren’t paying enough attention to trade deals between non-Western economies that could leave the U.S. and its allies short of key commodities – and paying higher prices for them.

CHINA’S REOPENING

Because China is the world’s biggest importer of many commodities, especially oil, the trajectory of its economy will be a key part of the U.S. inflation story in 2023.

After two years of imposing strict lockdowns under a Covid Zero policy, China has abruptly reversed course and is trying to open up. Right now that’s proving traumatic, amid a wave of virus cases and hospitalizations that are slamming output.

But Anna Wong, chief U.S. economist at Bloomberg Economics, says the likelihood is that the Chinese economy will be fully open by at least the second half of 2023 – which could drive energy prices some 20 percent higher and send U.S. inflation back up. In that case, she says, “headline U.S. CPI would bottom out midyear before climbing again in the second half.”

HOUSING: A QUESTION OF TIMING

With interest rates near zero and millions of Americans in search of more space, the pandemic set off a housing boom that’s helped drive up inflation.

Real-time data suggest that the surge in rents and home prices is over now. But because of the way housing is captured in official inflation figures – which reflects the fact that rental prices are locked in over the span of a lease – there’s typically a lag before the latest market conditions show up.

The cost of housing will be “the big story that everyone’s watching, how quickly it comes down,” says Omair Sharif, head of Inflation Insights.

Sharif expects the turnaround to start showing up in monthly numbers quite soon – “call it February, March, something like that” – but he says Fed officials are less optimistic and don’t see much relief from housing inflation until much later in the year.

WHAT KIND OF INFLATION?

One caveat to all the above is that there are lots of ways to measure inflation. The differences between them didn’t matter much in 2022 – because they were all way too high for anyone’s comfort – but will be more significant this year.

One key distinction is between the CPI, generally seen as the standard, and the personal consumption expenditures price gauge that the Fed targets for its 2 percent goal. The PCE measure gives more weight to health care and less to housing than the CPI. Another is between headline rates of inflation and so-called core measures, that strip out more volatile items like gasoline and food.

Citigroup, for example, forecasts that headline CPI inflation will slide to 2.5 percent in the second quarter – a level that would probably feel like mission accomplished to many – before picking up steam once again. And it sees core PCE inflation ending the year at 4.1 percent – which the Fed almost certainly wouldn’t view as a win.

One consolation for ordinary Americans: if experts are obsessing over technicalities like these, the worst of inflation is probably over.

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