Goldman Sachs’ top-notch US economics team has come up with the ten most important questions facing investors this year. They include some pretty in-the-weeds stuff. So I’ve plucked out what I think are the three most important questions – and their answers – to give you an idea of what to expect for 2023.
Question #1: Will the US economy go into a recession?
According to Goldman’s economists: no. But they’re straying from the herd on that view. Consensus puts the probability of a US recession in the next 12 months at a hefty 65%, while Goldman sees it at just 35%.
The Wall Street Journal 12-month recession odds survey. Sources: The Wall Street Journal and Goldman Sachs Global Investment Research.
That suggests that Goldman’s economists see the US economy achieving the Goldilocks soft-landing scenario – the one in which those interest rate hikes from the Federal Reserve manage to slow the economy just enough to bring down inflation, but not so much that it pushes the whole thing into a recession. And they see it playing out in that perfect way for two major reasons. The first of those has to do with inflation. You see, they believe that we don’t actually need a recession to tame the beast of inflation. They predict that an extended period of lower growth will actually be enough to rebalance the demand and supply, including the mismatch in the labor market where rampant wage pressures have pushed prices higher. They say this process has already been under way, but still has much further to go this year. They do admit that finding the sweet spot with monetary policy (basically, interest rate changes) to bring about this outcome is no easy feat and uncertainty about how sticky inflation could end up being is still top of mind.
The other reason – and, the far more interesting one if you ask me, as it’s such a hot topic in economics and finance – is the time it takes for the effects of the Fed’s interest rate hikes (what’s known as monetary policy tightening) to be felt by the general economy. In a nutshell, Goldman sees a much shorter time lag – roughly two quarters – between rate hikes and their impact on economic growth, compared to what other economists see. That’s huge, because Goldman is essentially saying that the worst effects of those hikes have already occurred and are now set to fade over 2023, meaning the economic growth outlook should be more resilient. And since much of the monetary tightening happened in the first half of 2022, along with the end of government stimulus (what’s known as fiscal policy tightening), Goldman expects the peak effects of the combined tightening to fade substantially as the year gets under way. Its model sees investors as forward-looking and the economic effects of rate hikes as occurring when the market anticipates them rather than when they are actually delivered.
Effect on US GDP growth from fiscal and monetary policy tightening. Source: Goldman Sachs Global Investment Research.
Question #2: Will unemployment spike?
No, say Goldman’s economists. There will be an adjustment, they say, but mostly it’ll be that there will be fewer job openings out there, not more unemployed people. Vacancies already are falling, in fact, but the layoff rate is low and the re-employment rate of short-term unemployed workers is humming along, indicating that there’s still strong labor demand. And so there’s not likely to be a big spike in joblessness.
There’s a historical relationship between job openings and the unemployment rate, and Goldman is betting that it’s going to be a lot lower than usual this time around. See, Goldman predicts the job openings rate will fall by 1.7 percentage points, which would suggest that the unemployment rate would increase by 2.6 percentage points, topping 6% by the end of 2023. But Goldman doesn’t see it moving that high: it sees a peak unemployment rate of 4.2% in early 2024 from the current 3.7%. That’s less than the Fed expects, and it’s only about one-third of the unemployment increase that’s typical in a shallow US recession.
Unemployment rate forecasts. Sources: Federal Reserve and Goldman Sachs Global Investment Research.
Question #3: Will the Fed cut interest rates in 2023?
That’s also a no. Goldman expects the Fed to hike three more times – in 0.25 percentage point steps in February, March, and May – and then to sit tight for the rest of 2023. This would lead to a fed funds rate of 5-5.25%, versus the market’s consensus expectation of a 4.75-5% peak rate, followed by some rate cuts that leave the rate around 4.4% at the end of the year.
Goldman Sachs and the market’s consensus expectations for the fed funds rate. Source: Goldman Sachs Global Investment Research.
Goldman’s economy pros just don’t see a strong case for the Fed to be lowering interest rates this year. They see inflation declining, but they’re doubtful it’ll fall enough to provide the Fed with confidence that it won’t pop back up again. It’s clearly more an art than a science in determining whether an inflation decline will be seen as sustained enough by the Fed in order to warrant a push to cut rates. There is lots of uncertainty around this key macroeconomic question.
For now, Goldman sees rates being hiked and then kept there unless something breaks – if the economy falls into a deep recession, for example, one that leads to an unexpected surge in joblessness. This year, the economy will already get a little lift, as the drag on growth from previous fiscal and monetary tightening fades, leading to better, more resilient growth. And that’s going to take a little pressure off the Fed, and let it leave rates as they stand for a bit longer. Rate cuts, Goldman says, will come later, sometime between 2024 and 2026, most likely.
Luke Suddards is an analyst at finimize.
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