Here Are Goldman’s “Top 10 Questions For 2017”

Two of the most read posts since this site’s inception have revolved around Goldman Sachs’ trade ideas and economic projections. Here they are:

Goldman’s Top Trades For 2017

Goldman Predictions No Better Than Coin Flip, Bank Admits

There are any number of reasons why readers are particularly interested in what the bank has to say. The “good” folks at 200 West have a reputation for being ahead of the game relative to their peers and yet they’re also known for “muppetizing” (a term made famous by Greg Smith, an outgoing employee who penned an Op-Ed for The New York Times in 2012) clients, who the bank appears to view with some measure of disdain. And don’t forget the whole “revolving door” dynamic that’s earned Goldman the nickname “Government Sachs.”

Taken together, all of that means the bank i) probably has an informational edge, ii) probably will use that edge for their own gain before they’ll even consider letting clients in on what they know, and iii) definitely influences the decisions of global policymakers.

So do the bank’s calls give us a window into the minds of those who are perpetually ahead of the game? Or should we take what Goldman says with a grain of salt and view their predictions as contrarian indicators? Or should we read their analysis with a mind towards trying to divine something about the future course of policy?  Well, probably all of the above, which is why I suppose so many people are interested.

And so, with the stage thus set, I bring you excerpts from Goldman’s “Top 10 questions for 2017”:

1. Will growth remain above trend? Yes. Admittedly, the expansion is quite advanced. It has already lasted about 18 months longer than the median completed expansion since the mid-1800s. And while expansions do not die of old age, history shows that they are at greater risk when spare capacity is exhausted, as it probably is now. So it is especially important to monitor whether growth may be running out of steam.

2. Will the incoming administration enact major tax-related legislation? Yes. Some type of tax legislation seems very likely to pass in 2017, for three reasons. First, Republicans have it in their ability to pass tax legislation without Democratic votes, by using the reconciliation process. Second, tax reform—or at least a tax cut—was an important aspect of the presidential campaign. Third, it has been a top priority for congressional Republicans, and particularly House Speaker Paul Ryan, for several years.

3. Will the housing recovery continue? Yes, at a moderate pace

4. Will consumption continue to outperform capital spending? No. Growth has been quite unbalanced over the last two years. Since the third quarter of 2014, real personal consumption has grown 3% (annualized), more than 1pp above the economy’s estimated long-term trend of 1¾%. In contrast, real business investment has stagnated.

5. Will the labor market overheat? Yes, slightly. The starting point at the end of 2016 is approximately full employment. Some indicators such as the broad underemployment rate U6 and summary measures of nominal wage growth still show a small amount of labor market slack. Others such as the job openings rate and the level of skill shortages are already consistent with a modest amount of labor market overheating.

6. Will wage growth hit our 3.0%-3.5% estimate of its full employment level? Yes. Wage growth has accelerated meaningfully in recent years as the labor market has tightened (Exhibit 9). The firming has been most pronounced at the bottom end of the wage distribution, aided by minimum wage hikes at the state and city level that are likely to continue in coming years—even if an increase at the federal level now appears very unlikely.

7. Will inflation reach the Fed’s 2% target? Yes. Headline PCE inflation has picked up from a low of 0.2% year-over-year in September 2015 to 1.4% as of last month. If energy prices hold around the current level, PCE inflation should reach the Fed’s 2% target by February or March.

8. Will the Fed hike faster than implied by market pricing? Yes. At present markets are discounting an end-2017 federal funds rate of about 1.2%—54 basis points (bp) above the current effective funds rate, and implying just over two 25bp rate hikes for the year. We continue to expect the FOMC to raise rates three times, with the first hike coming in June.

9. Will the market’s terminal funds rate estimate continue to rise? Yes. In our annual questions for 2016 we said the same, but decided the verdict was inconclusive (see here for our review). Forward OIS rates declined for much of 2016, but increased sharply after September. Markets are now pricing a terminal funds rate of 2.5%—virtually identical to the level at the end of 2015, but up more than 100bp from the 2016 lows. Even after the latest increase these estimates still strike us as quite low.

10. Will the Fed start to shrink its balance sheet? No. Fed officials have said that the size of the central bank’s balance sheet will likely remain unchanged until funds rate increases are “well under way”.

There you go. See you back here next year, same time, same place, to see how many of these prognostications were proven right (or wrong).

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