Four-Step Program

If you ask highly qualified professionals, many of whom probably spent the rough equivalent of a 20% house downpayment on their education, the odds of a US recession in the next 12 months are 63%.

That’s according to the latest Wall Street Journal survey of economists, released last month.

As ever, such figures represent wholly quixotic attempts to science-ify the unscientific. With sincere apologies to economists, analysts and would-be macro mavens, there’s no way to reliably assign odds to economic aggregates which, in the final analysis, represent nothing more than the net whim of 300 million people, all pursuing what they believe to be their “best” interests. Note the scare quotes. Not everyone has the same definition of “best.”

When we talk deterministically about the economy, we make specious assumptions about human behavior. “Economic man” may well be, as Heilbroner famously put it, “a pale wraith of a creature who follow[s] his adding-machine brain wherever it [takes] him,” but not everyone is an “economic man” (or woman) all the time. In reality, people are driven by all manner of considerations. The profit motive is among the most widely shared, but it’s hardly universal. If you’re addicted to opioids, for example, your concern with money is contextualized entirely by the necessity of using it to procure percocet. If there are other, more expedient means of procurement, the profit motive disappears. We needn’t conjure such a sad example to make the point. I’m not sure if readers are aware of this, but you can become addicted to running. It’s a more healthy addiction than opioids, but if you talk to serious runners, they’ve gotta run (to lapse briefly into a colloquial cadence). Depending on what time of day it is, and how their internal clocks are set, economic considerations take a back seat to exercise.

The point is just that when we assign odds to economic outcomes, we tacitly assume that the vast majority of people are, by and large, motivated by the same set of concerns, when in fact they aren’t. I’d argue our failure to appreciate that simple point played a large part in economists’ inability to forecast inflation and labor market outcomes during the pandemic.

In any event, that’s a wholly circuitous way of bridging the 63% recession forecast from the Journal‘s survey of economists, with Goldman’s odds, which are materially lower, at just 35%. As you can imagine, Jan Hatzius doesn’t attribute the disparity to economists’ failure to incorporate the pervasiveness of exercise addiction into their forecasts. Rather, Goldman’s relatively benign recession odds (which, by the way, are still double the unconditional probability in any given 12-month period) are explainable by way of what Hatzius described as a “non-recessionary four-step path from the high-inflation economy of the present to a low-inflation economy of the future.” It’s a narrow path to a soft landing.

Goldman’s four step-program begins with a transition to below-trend, but still positive, growth. That’s “already occurred,” Hatzius said, and it “looks durable.” He wrote off Q3’s optically robust GDP print as the product of “a spurious boost from noise in the foreign trade data.” Instead, he favors the bank’s in house current activity indicator, which suggests a more pedestrian (and, in the current context, more healthy), 0.7% growth rate. That should persist in 2023. If you ask Goldman, a recovery in real disposable personal income (i.e., from fading inflation and still high wage growth) will be offset by tighter financial conditions, leaving growth to drift along below-trend, a desirable outcome for a Fed fighting inflation.

The second part of Goldman’s plan entails a rebalancing of the labor market, which Hatzius claimed is “on track.” I’d have to quibble with that, a least a little bit. The latest JOLTS data wasn’t encouraging, and the October jobs report was mixed. Hatzius knows that, of course. He addressed it. “We think some of [the NFP] strength may reflect residual seasonality and distortions in the Labor Department’s birth-death mode and while our jobs-workers gap rebounded to 4.7 million on the back of a rebound in JOLTS job openings in September, this looks like noise,” he said, noting that “other JOLTS measures such as private-sector quits and gross hires eased in September, and timelier indicators of job openings from Linkup and Indeed declined further in October.”

The figure on the right (above) does suggest things are normalizing, albeit slowly. It’s not reasonable to expect everything will inflect all at once, so it’s admittedly disingenuous to overplay any one JOLTS report, inclined as I am to do just that.

For Goldman, the “most encouraging” news (and this is the third step to a soft landing) is what Hatzius described as a “slowdown in nominal wage growth.” Again, I’d be remiss not to at least mention that you have to squint to see the slowdown on some key metrics. Q3 ECI, for example, was still very hot. Hatzius conceded that, and also that the Atlanta Fed’s wage tracker still suggests YoY wage growth has only slowed “modestly.”

Thankfully, Goldman has its own indicators, both of which suggest progress. “Our composition-adjusted average hourly earnings measure — which removes the impact of distortions — has slowed from 7% in July 2021 to 4.5% in October 2022 on a six-month annualized basis [and] our monthly wage survey composite, which aggregates business surveys on actual or expected wage changes, has fallen from a level consistent with 5.5% nominal wage growth earlier in the year to a level consistent with 4-4.5% now,” Hatzius said.

Although readings on Goldman’s indicators are still too high to be consistent with 2% inflation, they’re moving in the right direction (figure above).

Of course, the proximate cause of everyone’s consternation — inflation — remains stubbornly elevated. All three steps mentioned above (engineering below-trend growth, normalizing the labor market and corralling wage growth in order to short circuit the wage-price spiral) are all in the service of lower inflation. And there’s been “much less progress” on that front, as Goldman put it.

The good news is, a familiar list of ostensible leading indicators point to relief ahead. I’ve been over most of those indicators on numerous occasions (figure below, for example).

Hatzius mentioned the ISM components and used car prices, as well as stabilization in asking rents on new leases.

Nevertheless, he conceded that improvement across various forward-looking metrics “will take much longer to feed into the official measures” of inflation.

You can draw your own conclusions. Goldman suggested the US economy is taking steps down “the narrow path” to a soft landing. Hatzius called the non-recessionary scenario sketched above “very plausible.”

In closing, I’d note that if you’re inclined to call this yet another article in which my initial editorializing was infinitely more entertaining and, perhaps, more insightful, than the subsequent analysis, you wouldn’t be wrong.