Last week, Bill Dudley said the Fed should stop “sugarcoating” the message.
He meant that Jerome Powell would do better to tell the public an unvarnished version of the truth: The Fed needs to tighten policy enough to push up the unemployment rate and slow the economy in order to short circuit any wage-price spiral and lean against demand-pull inflation.
Dudley also said rates may need to be 4%, 5% or even 6% eventually. “Whatever it takes,” so to speak.
In essence, Dudley suggested a slowdown is necessary, a sentiment his former employer (Goldman, not the Fed) echoed in a new note cutting the bank’s annual GDP forecasts for the US economy.
The 16-page rationale served as an update to research released last month and discussed briefly here. It also built on a note published Saturday, when Spencer Hill warned on “consumer caution” in the course of trimming Q2 estimates.
Read more: Goldman Cuts US GDP Forecast. Cites Consumer Slowdown
To briefly recap, Goldman defines the “jobs-workers gap” as the difference between the total number of jobs (measured by employed workers plus job openings) and the number of workers (the labor force). On that measure, the US labor market is the tightest in at least 70 years.
The bank suggested that in order to bring wage growth down to levels consistent with 2-handle inflation in 2023 and 2024, the Fed needed to narrow the jobs-workers gap by 2.5 million, which would require policy to slow GDP growth by another 75bps to 1-1.5% for a year by generating an incremental 75bps of tightening in the bank’s financial conditions index.
Those estimates vary in accordance with the actual, realized tightening in financial conditions and the evolution of the data. In the bank’s latest assessment, Joseph Briggs said financial conditions needed to tighten by between 50-100bps in order to generate a slowdown of between 0.5% and 1%, which “would likely be enough to lower job openings, narrow the jobs-workers gap, and bring wage and price inflation back to more normal levels.”
The figure (above) illustrates the five-step process Goldman says the Fed needs to complete.
The good news is, financial conditions now reflect enough tightening to “restore balance to the labor market and cool the economy, Briggs wrote.
The bad new is, that tightening impulse needs to “stick,” as it were, which implies a Fed that generally delivers on what’s priced by markets. That, in turn, means growth forecasts need to come down.
And so, Goldman cut forecasts. Growth will be +2.5%, +2.25%, and +1.5% in 2022Q2-Q4 and +1.25%, +1.5%, +1.5% and +1.75% in 2023Q1-Q4, respectively. The implication is that the US economy will grow 2.4% on an annual basis and 1.25% on a Q4/Q4 basis this year, down from the bank’s previous estimates of 2.6% and 1.6%. Next year, annual growth will be just 1.6%.
As the figure (above) shows, Goldman is now meaningfully below consensus.
As discussed at some length here late last month, we’re asking something very difficult of the Fed: They need to reduce job openings while avoiding a large increase in the unemployment rate. Put differently, the Fed’s task is to create just enough drag to squeeze out superfluous job openings while avoiding any actual job losses. As Jan Hatzius put it, “The key to a soft landing is to generate a slowdown large enough to persuade firms to shelve some of their expansion plans, but not large enough to trigger sharp cuts in current output and employment.”
Unfortunately, history suggests declines in the rate of job openings concurrent with increases in unemployment are basically synonymous with recessions.
That said, Goldman suggested this time could be different. Obviously, job openings are plentiful to the point where analyzing the JOLTS data is akin to looking in a funhouse mirror. That suggests some scope for reducing the number of open positions without firing people, especially considering employers are desperate to retain talent.
Additionally, Briggs said the largest disparities between openings and workers are in sectors that are particularly sensitive to tighter financial conditions. He demonstrated that with a series of regressions.
And yet, he didn’t skirt the issue. “Nevertheless, the historical relationship between unemployment and job openings and a slowdown in growth to below trend for an extended period suggest that we should expect at least a modest increase in the unemployment rate,” Briggs wrote.
Ultimately, Goldman isn’t forecasting a US recession. I’d remind readers that in historical instances where the three-month moving average of the unemployment rate rose by a half percentage point or more, a downturn always occurred.
“The key to a soft landing is to generate a slowdown large enough to persuade firms to shelve some of their expansion plans, but not large enough to trigger sharp cuts in current output and employment.”
That’s just great! They want to tame inflation, which is a shortage of supply problem, by stopping business from expanding their production. Brilliant!
And there you have it. The Fed can really only mess with the demand side. The supply side mess is down to the environment (pandemic) and the collateral damage caused by businesses sailing too close to the wind with their JIT strategies. Increased product variety, market segmentation, and margin pressures made it difficult for supply chain managers to keep things moving smoothly. When a big disruption came along (and it still lingers everywhere) the system broke down. No Fed help for this. This whole situation will get a bunch of Republican elected this fall but they won’t be able to do anything about the situation either, except bitch about the “libs” who caused all this with critical race theory or some such.
If the Rs take the house, it is because the extremist militant arm of the party won a bunch of seats. As the house controls spending, expect severe austerity policies in a nihilistic effort to “destroy Biden”. The pain it would cause the country doesn’t matter to them in the slightest. They see themselves as God’s Wrath. Yes, they are psychotically delusion to this level. They will look to finish what trump started in destroying the country. With the current tenuous economic backdrop the reasonable expect is for a full on depression.
As for the likelihood of the Rs taking the house: before Roe was under threat, the Rs were almost assured of taking the house even if the Senate margin widens for the Ds. Now, the Rs might have just lost the white suburban woman vote, aka the swing vote that sunk the Rs in 2018 and trump in 2020.
I just don’t see how the same Fed that has been behind the curve for almost a year now suddenly catches up enough to detect when this exact moment of slowdown occurs so they can take their collective feet off the brakes. And how to do you increase unemployment by half a percent when there are 11.5M jobs unfilled already and essentially minimal immigration without completely blowing up the entire economy?
Dudley’s insistence that the present situation is the same as the early 80’s is starting to feel pathological. There is little evidence to prove it. Maybe that evidence presents itself eventually, but maybe it doesn’t. That it is a known unknown is the exact reason to not force a global depression, the logical result of a 6% FED funds rate.
The most obvious argument against Dudley’s delusions is there is no wage price spiral. Low income individuals are seeing large increase 10-12% and yet their income is still too low. All the higher wage earners (the majority of wage earners) are gaining <4%. It’s almost as though he’s saying raising wages for low income earners is a terrible outcome and we should make sure these people stay in poverty.
@Hopium, that is a very interesting point, and was new information to me.
I am pretty happy to see wages going up, people getting jobs, and workers clawing back some leverage.
One possible trick would be to open up immigration: increased labor (both skilled and unskilled) would ease Services wage based inflation and simultaneously allow for more consumption (with more consumers). We do need workers for adding efficiency via renewables and transit, if you don’t build those you might as well keep Putin in power by paying in ruples.
Oh and don’t forget new housing requires lots of labor too – you can’t live in software, VR, or TikTok. (Or you can let old/inefficient housing stock continue to be a bottleneck for Millenials and GenZ and take Rents)…
Rates of +4% and it will end in tears…