The risk was, and in the minds of many still is, that the Fed will have to do more. That even after 525bps of rate hikes in 16 months, policy isn’t “sufficiently restrictive” to curb inflation through below-trend growth.
Conceivably, the still huge size of the Fed’s balance sheet could be offsetting some of the tightening even as QT proceeds. At the least, we can conjecture that a brisker pace of runoff could be helpful in cooling an economy that’s still too hot to be consistent with price stability as we current define it.
And yet, recent inflation readings out of the US point to progress and thus reduce the risk of over-tightening. As Goldman’s Kamakshya Trivedi and Dominic Wilson put it, channeling the quip about expansions not dying of old age, but rather falling victim to foul policy play, the “motive for murder” is less clear now.
“The most plausible reason for recession was that the Fed would have to ‘murder’ yet another economic recovery to subdue inflation,” Trivedi remarked. “That risk is not eliminated, but to the extent the disinflation process progresses further it should gradually diminish.”
Generally speaking, Trivedi and Wilson expressed guarded optimism. Although another recession is inevitable at some point, a downturn in the US may not be imminent, they wrote, echoing a refrain heard more often these days.
They nodded to the Fed and Treasury response to March’s banking turmoil, said that although the persistent curve inversion is challenging for some business models, “the scale of the problem does not appear to be systemic” and noted that so far anyway, the read-through from March’s theatrics for credit provision “seems less scary than expected.
In addition, “broader financial conditions have eased meaningfully,” they went on. That’s thanks in no small part to the equity rally and ever tighter high grade spreads, which have retraced the SVB widening.
That too bodes will for the economy in the second half, if not perhaps for the Fed’s inflation-fighting efforts. Goldman’s indicator of current activity in the US has inflected, and is now in positive territory.
Ultimately, Trivedi and Wilson described Goldman’s overall global market view as “uncomfortably long.” “Our simple conclusion is that the data are likely to continue to support both a deepening and perhaps a broadening of the market shift towards lower inflation and recession risks,” they said.
Although the bank conceded that a lot of the growth and inflation relief is in the price (and also in positioning), Goldman “still think[s] a pro-risk/pro-carry view makes sense, uncomfortable though it feels.”
Of course, the biggest risk is still inflation and hawkish policy surprises. “Policymakers’ reticence to signal an ‘all clear’ could put the brakes on the market’s optimism periodically, perhaps as early as this week’s FOMC, but a more meaningful challenge would need a sharper shift back in the inflation news,” Trivedi said, adding that “even if the Fed moves further than expected, monetary policy is unlikely to be a sustained source of volatility and could ultimately help to compress it, as long as the debate stays anchored around a possible further 25bps hike in the next meeting or two.”
