Economy

The US economy can dodge recession: Goldman Sachs

By Market Index
Mon 21 Nov 22, 3:59pm (AEST)
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Key Points

  • Goldman Sachs expects the Federal Reserve to hike another 125bp to a peak of 5-5.25%
  • The broker expects no rate cuts by the Fed in 2023
  • 65% of forecasters in the latest Wall Street Journal survey expect a US recession

The US should narrowly avoid recession as core personal expenditure inflation (PCE) inflation slows from 5% now to 3% in late 2023: At least that’s conclusion of Goldman Sachs research which expects the Federal Reserve (The Fed) to hike another 125bp to a peak of 5-5.25%.

But the broker is not expecting any rate cuts in 2023.

Unlike a year ago, when Goldman’s forecasts for both 2022 and 2023 were below consensus, due to the expected negative impact of monetary and fiscal tightening, the broker’s current 2023 forecast is well above consensus.

Goldman estimates a 35% probability that the US economy enters recession over the next 12 months, well below the median of 65% among the forecasters in the latest Wall Street Journal survey.

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Why a recession looks unlikely

When arguing why its recession probability remains well below 50%, Goldman simply believes there is no sign of it within incoming activity data, including:

  • The advance GDP report showed 2.6% (annualised) growth in third quarter.

  • Nonfarm payrolls grew 261,000 in October.

  • There were 225,000 initial jobless claims in the week of November 5.

Fundamentals point to positive growth

While Goldman admits the tightening in financial conditions is weighing heavily on growth, to the tune of nearly 2pp (percentage points) at present, the broker argues that fundamentals point to positive growth in coming quarters.

For starters, the broker points to real disposable personal income which is rebounding from the plunge seen in first half—when fiscal tightening and sharply higher inflation took their toll—to a pace of 3%-plus over the next year.

“…while there are risks on both sides, we think the real income upturn is likely to be the stronger force as we move through 2023,” the broker notes.

“… the financial conditions drag will likely diminish assuming Fed officials do not deliver dramatically more tightening than the rates market is currently pricing.”

This cycle is different

Goldman believes the differences embedded within the current cycle – relative to previous high-inflation periods – explains why the Fed can bring down inflation by 2pp over the next year with only a half percentage point increase in the unemployment rate.

As a case in point, the post-pandemic labour market overheating showed up not in excessive employment but in unprecedented job openings.

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“… job openings surged in 2020-2021 as employers sought to keep up with the strongest economic recovery on record amidst continuing Covid fears and exceptionally generous unemployment benefits,” Goldman notes.

“However, employment as a share of the labour force only rose to roughly the pre-pandemic level, not above.”

The broker reminds investors that the environment now looks very different.

With demand having slowed, unemployment benefits having normalised, and excess savings coming down, Goldman notes job openings and jobs-workers gap—total labour demand minus total labour supply—is coming down quickly.

Other key drivers

The second reason this cycle is different, argues Goldman is that the recent normalisation in supply chains and rental housing markets is a source of disinflation not seen in previous high-inflation episodes such as the 1970s, and it is only beginning to show up in the official numbers.

“The third reason is that long-term inflation expectations remain well-anchored, especially relative to the 1970s,” the broker explains.

“Measures of short-term inflation expectations remain relatively high, but much of this probably reflects the spike in commodity prices and should wane if commodity prices level off.”

Core PCE inflation to tumble

In summary, Goldman expects year-over-year core PCE inflation to decline from 5.1% in September to 2.9% in December 2023.

The broker also expects supply-constrained durable goods with margins that remain elevated, such as used cars, to drive nearly half of the slowdown in overall core inflation.

“With a resilient labour market and still elevated inflation, we don’t see any rate cuts in 2023.”

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