Goldman sees risks rising for a 'mild' recession, but not for at least another year

Published Thu, Mar 31 20223:28 PM EDTUpdated Thu, Mar 31 20226:38 PM EDT

Like many on Wall Street, Goldman Sachs economists are seeing elevated recession risks ahead. But the news isn't all bad. Recession talk has heated up as a long-revered signal in the bond market has come close to being triggered: The 10-year Treasury yield is perilously near falling below the rate on the two-year note, a phenomenon known as an inverted yield curve that has been a highly accurate harbinger of downturns through history. Goldman considered a variety of such signals both in the fixed income space as well as stocks and options and came to a conclusion: Risks are not imminent but are rising. "The probabilities implied by most of the single asset indicators we examine imply a very low chance of recession in the next six months, and somewhat higher probabilities over the next 12 months and the 12 months following that," economist Vickie Chang said in a note for clients. Specifically, the firm sees "close to no chance" of a recession over the next 12 months, but a 38% probability in the following year. In broad strokes, that's consistent with the signal from the yield curve. Even when it inverts , that only intimates a probability out in the future, and recessions have sometimes occurred years after the signal is tripped. Recession 'would probably be mild' There's more, though. Goldman thinks that even if the economy enters a period of negative growth, it won't be anything major. "The inversion of the policy curve is consistent with a market that is placing some weight on the possibility of recession," Chang wrote. She added that while Goldman's economic team sees "the risk of a U.S. recession this year as higher relative to an average year, a recession if it were to occur would probably be mild by historical standards as the economy lacks major financial imbalances that would exacerbate a slowdown." The gap between the two-year and 10-year around Thursday's bond market close was about three basis points , or 0.03 percentage points. While that spread has remained narrow, the gap between the three-month bill and the 10-year, a part of the curve favored by the New York Fed as an indicator, is nearly 180 basis points. That level implies single-digit 12-month recession probabilities, according to the New York Fed's calculations. The gap was 159 basis points at the end of February, a level that the central bank interpreted as a 6.1% chance. Still, markets remain on edge . 'Exogenous shocks' pose a danger While an inverted curve itself can cause damage to the balance sheets of banks that borrow short and lend long, the relationship itself is more indicator than igniter. Indeed, the past two recessions were associated with the financial crisis of 2008 and the pandemic in 2020. But the narrowing of the curve indicates a level of fear that can lead to bigger problems. "A negative yield curve signals the U.S. economy is especially susceptible to exogenous shocks that lead to recession," Nick Colas, co-founder of DataTrek Research, wrote in his daily newsletter Tuesday evening. "They occur late in an economic cycle, which means output is running close to potential, and when markets are wrestling with the question of whether the Federal Reserve is about to make a policy mistake by raising interest rates too far." The Fed is in fact poised to raise rates considerably, a significant factor in bond market movements. Goldman is expecting the Fed to hike rates a total of 200 basis points this year, though it acknowledged upside to that should the policy tightening not slow down the economy sufficiently to control inflation. Markets currently are pricing in rate hikes at every Fed meeting this year totaling at least 225 basis points, according to CME Group data .

A statue of George Washington is pictured in front of the New York Stock Exchange on Wall Street in New York City.

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Like many on Wall Street, Goldman Sachs economists are seeing elevated recession risks ahead. But the news isn't all bad.