- The Federal Reserve's abrupt policy pivot has eased financial conditions and reduced the odds of a recession to just 10% over the next four quarters, from 20% at the end of the fourth quarter, Goldman Sachs economists said.
- The economists studied the reasons for the easier financial conditions and said the Fed was largely responsible.
- The Fed's dovish shift was seen as an intentional effort to reduce downside risks and it appears to have worked as planned, they said.
Goldman Sachs economists say Federal Reserve policy has reduced the risk of a recession over the next year to just 10% from a previous 20% at the end of the fourth quarter.
The economists concluded that the improvement in financial conditions since the beginning of the year is in large part due to the abrupt policy shift by the Fed, after it raised interest rates by a quarter point in December.
But the Fed's success in fighting off a recession may actually make it reconsider its policy of holding off interest rate hikes, as the central bank itself has noted, the economists wrote.
"The Fed's dovish shift was likely designed to decrease downside risks, and our findings suggest that this has largely worked as planned. As the lingering effects of the Q4 tightening gradually fade away, the Fed may eventually be willing to revisit the need for patience, as indicated in the January minutes," they wrote.
The Fed was expected to release the minutes Wednesday of the Federal Open Market Committee's March meeting, when it held rates steady. The central bank, after that meeting, released revised economic and interest rate forecasts that showed expectations for a weaker economy and no rate increases this year, reinforcing the "patient" stance officials had been discussing.
"Financial conditions have eased significantly in 2019, with the FCI [financial conditions index] now reversing roughly 80% of the tightening in 2018Q4," the economists wrote, adding growth has also picked up. Financial conditions include such things as the stock market's performance and interest rate levels.
Economists have been ratcheting up expectations for first-quarter growth and now many of them see it tracking closer to 2% than 1%, as it had previously. The yield curve is no longer inverted between the 10-year note yield and the 3-month bill yield, as it had been several weeks ago. A yield curve inversion is seen as a reliable recession signal.
Treasury yields have also risen, from the lowest levels in more than a year. On Wednesday, the 10-year yield was at 2.47% in late morning, after touching 2.51% earlier in the day.
The economists said the easing of financial conditions was by far the biggest influence on the reduction of downside risks.
"Our analysis also suggests that downside risk will likely be contained in the near-term, barring another large tightening in the FCI. In addition to the reversal of much of the Q4 FCI tightening, US growth momentum has improved and global growth appears to be stabilizing," they wrote.
Correction: On Wednesday the 10-year yield was at 2.47% in late morning, after touching 2.51% earlier in the day. An earlier version misstated the day.