Goldman Sachs' Forecast: Recession Odds Increase

Some interesting comments came out from Goldman Sachs today. Goldman economists raised the odds of recession in their latest forecast but they also said they believe the Fed will act even more aggressively to prevent it.

Goldman this morning changed its forecast for the Fed funds rate to 3% by mid-2008, a whole point lower than its last forecast. "The main reason is that the worsening housing downturn has pushed the risk of a U.S. recession in 2008 to 40-45%, from around 30% previously," the Goldman economists said in a note.

"We're certainly well below consensus," said Goldman senior economist Ed McKelvey on "Squawk on the Street." "We think the housing situation is by no means over and probably will not be over throughout 2008 either," he said. "The reason for that is because there's a mixture of secular and cyclical stuff going on in housing. You're not only correcting the bubble, you're correcting all the loan excesses."

The Goldman economists say an overall recession isn't in their baseline forecast. They cut their real GDP growth forecast just slightly to 1-1/2% on a fourth quarter to fourth quarter basis from 1-1/4%. The economists note the Fed officials have not signaled they plan to ease further but they are expected to change their minds when the data shows more of the housing-related damage or financial markets continue to be "strained."

McKelvey said the rate cuts would be dollar negative but "the dollar already has moved...There is a lot of expectation built in already to asset prices about U.S. economic weakness. So whether or not it's a sustained move down for the dollar or whether it's a short term negative, not sure."

Goldman also forecast the yield on the 10-year between 3.70% and 3.90% for the first three quarters of next year before reaching 4% in the fourth quarter. Goldman's note also included a caveat. Recession becomes more likely if foreign demand falls off, the pace of layoffs increase significantly, or the Fed fails to ease aggressively.

Busy Morning
Goldman Sachs equities analysts were also busy today. In a note, they said the softening economy has led them to change their already defensive stance on some sectors. They downgraded airlines, autos, lodging, office furniture, REITs, staffing and truckers to cautious from neutral. Integrated oil, oil services, IT processors, metals and software were taken to neutral from attractive.

Goldman also upgraded utilities to neutral from cautious and defense, large-cap biotech, tobacco to attractive from neutral.

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