Goldman’s most out-of-consensus call for 2023 is arguably their most important.
Generally speaking, economists and market participants expect the world’s largest economy to succumb in the new year.
The Fed is avowedly determined to cool domestic demand because that’s the only lever monetary policy can pull when it comes to fighting inflation. The US is a services-based economy, and labor is a big part of the cost structure in the services sector. The goods-to-services shift was a positive development to the extent it helped cool goods inflation, but stubbornly robust demand for services risks persistent upward pressure on wage growth, which in turn raises the odds of the dreaded wage-price spiral.
If you believe Jerome Powell is as determined as he claims to be when it comes to bringing inflation back down to 2%, then you probably believe a US recession is inevitable. The path from 8% headline inflation to 3.5% or 4% is pretty easy to trace. The path from 3.5% to 2% much less so in the current environment. Absent a real downturn, it’s not obvious that 2% is attainable on a sustained basis, hence consensus expectations for a US recession.
But Goldman doesn’t necessarily buy it. “Our most out-of-consensus forecast for 2023 is our call that the US will avoid a recession and instead continue progressing toward a soft landing,” the bank’s David Mericle and Alec Phillips wrote, while asking and answering “10 questions for 2023.” “Part of our disagreement with consensus arises from our more optimistic view on whether a recession is necessary to tame inflation,” they added.
It’s not that the bank sees no chance of a downturn. Indeed, they put the odds at 35%, which seems high until you look at the distribution of consensus estimates.
The median puts the odds of a downturn in the next 12 months at 65%. I should note that even Goldman’s relatively optimistic view is between double and triple the unconditional historical average.
Mericle and Phillips suggested that as long as the Fed can keep growth below-potential for “an extended period,” the funhouse mirror-style distortions in the labor market can normalize, albeit “gradually,” with the end result being cooler wage growth and thereby cooler inflation. The historic nature of the imbalance between labor supply and demand (as reflected, for example, in the JOLTS data) suggests this process can play out without a large increase in joblessness.
Even if you don’t buy that (and the likes of Larry Summers certainly don’t), Goldman noted that the difference between their recession odds and consensus isn’t really about how much tightening is needed to bring down inflation. If that were the point of contention, Mericle and Phillips studiously pointed out, then both the Fed dots and market pricing would be more hawkish than Goldman’s terminal rate estimate. Instead, Goldman’s forecast actually implies a higher terminal rate than market pricing, and one that’s largely consistent with the new dot plot.
Much of the disagreement, then, is around the scope and timing of the drag from rate hikes already delivered. If you read “A ‘Gross Misinterpretation’ Of Milton Friedman,” you’re already familiar with the argument.
“We expect more resilience in underlying demand next year than consensus because our analysis indicates that policy restraint has played a very large role in slowing demand growth this year but will fade quickly next year,” Mericle and Phillips remarked.
As detailed more extensively in the linked article above, Goldman suspects the peak drag from tighter financial conditions on GDP growth is likely occurring right now. Some drag will persist for six quarters, though, so the peak impact on the level of GDP occurs after those same six quarters. At the same time, drag from fiscal policy is seen waning too.
Mericle and Phillips reiterated several key points from recent research. “The peak impact of rate hikes on GDP growth is front-loaded,” they said late Monday. “[O]ur approach recognizes that rate hikes affect the economy via broad financial conditions as soon as markets anticipate them, which in 2022 was well before they were delivered,” they added, noting that “some forecasters seem to confuse lags from monetary policy to GDP growth with lags to GDP levels.”
Of course, the bad news is that if Goldman is right and the US doesn’t enter a recession in 2023, the risks around terminal rate projections are skewed to the upside. The market is steadfast in its refusal to concede that and indeed continues to insist on a pivot to outright easing in the back half of 2023.
Don’t fight the Fed. Higher longer.
Plateau.
I would be curious about Goldman’s explanation of the very inverted US Treasury yield curve and how that affects the economy. I am obviously in the mild to significant recession camp and believe that the fiscal stimulus previously delivered is wearing out. I would also want to know where Goldman thinks the driver’s of growth at least enough to keep the GDP lights on will come from?
As I’m sure you can imagine, Goldman (and every other bank) has a breakdown of where they expect the growth to come from that’s granular enough to make even the most pedantic of interested parties blush. I mean, it’s just a matter of what’s worth highlighting and what isn’t, and whether there’s any utility for the average person in assessing the veracity of forecasts not just by major component, but by components within components within components. If you tallied up year-ahead US macro outlooks from every major bank, they’d run into the thousands of pages. Literally. And many of them will probably be revised by March. If I remember, I’ll run through some of the major assumptions, but I think I already have. I’ll go back and look.
I like the idea of Fed patience being a virtue for my portfolio. But my gut is fearful. And I’m dubious about the Goldman view, though encouraged to a degree. Honestly, there’s a part of me that wants to hurry the process and be done with Fed hikes. But I cannot say it won’t be protracted. Well, c’est la vie. Aside from patiently waiting, all I actually do in the market is buy low and sell high.
In 2021, in the USA, approximately 5.5 SSNs got issued, yet there were only 3,659,288 births. The difference (1.8M) represents SSNs primarily used for immigrants who are here to work. There are pathways to applying for an Employment Authorization Document (EAD) even if an immigrant entered USA illegally, such as “asylum or refugee” status. Imagine how tight the labor market would be without these workers! Answer: much worse.
As a country, we need to straighten out immigration right now.
please remind me why higher interest rates will depress food prices.
https://www.wbur.org/onpoint/2022/12/26/more-than-money-the-monopoly-on-meat
Excerpt: There are four major corporations in the American meatpacking industry. Tyson Foods, Cargill and two owned by Brazilian corporations, National Beef Packing Company and JBS. In 1977, the Big Four, as they’re commonly called, owned just 25% of the market. Many mergers later, the Big Four now control 85% of all meat packing in America. Cattle beef are a $67 billion industry in the U.S.
Cattle ranchers used to receive 62 cents for every consumer dollar spent on beef. Today, that’s dropped to less than 37 cents on the dollar. Meanwhile, the Big Four have tripled profits in the past two years alone.