Goldman still doesn't expect recession, going against most of Wall Street

Published Fri, May 12 20239:44 AM EDTUpdated Fri, May 12 20233:41 PM EDT

Goldman Sachs is holding strong on its no-recession call, insisting the economy is resilient enough to withstand a prolonged period of high interest rates and persistent troubles in the nation's banking industry. The firm still sees just a 35% chance the $26.5 trillion U.S. economy enters a contraction over the course of the next year. That call comes despite financial markets strongly pricing in the probability of a recession and the Federal Reserve's own economists warning of the same due to a likely credit crunch caused by banking problems. "Rates market participants have been most concerned about the risk that the banking turmoil will trigger a near-term recession," Goldman chief economist Jan Hatzius wrote in a note to clients. "But two months after the [Silicon Valley Bank] failure, the evidence for a big impact remains surprisingly limited." Indeed, reliable recession indicators such as yield curve inversions have been pointing to recession for months. The Fed's favorite indicator, the relationship between 3-month and 10-year Treasury yields, has been near historic highs in terms of inversion, most recently at 181 basis points. The inversion level at the end of April translated into a 68% probability of a recession, according to the New York Fed . A basis point is 1/100 of a percentage point. Much of that inversion can be traced to expectations for Fed rates, as expressed through the 3-month yield, and the outlook for growth, as viewed by the 10-year yield. Markets and economists primarily feel the central bank's aggressive campaign against inflation ultimately will pull the economy into a downturn. The road to no recession But Hatzius said policymakers may be able to achieve their soft landing. "At least so far, our read is that Fed officials have managed to put the economy on a course of gradual wage and price disinflation without the recession predicted by a large majority of economists," he wrote. The data lately has been mixed, with the labor market holding strong despite Fed policy tightening. Job openings , however, have fallen nearly 2.5 million over the past year, something Hatzius acknowledged has never happened without an accompanying recession. "Many economists take this observation as a sign that the worst is yet to come; we take it, instead, as a sign that this cycle is different," he said. Hatzius did warn the market is too sanguine about the outlook for rates. Despite repeated statements from Fed officials a higher-for-longer course is likely for interest rates as inflation remains well above the central bank's 2% target, the market is pricing about 75 basis points worth of cuts before the end of 2023, and more in 2024, according to CME Group data. Together, the cuts would shave about 225 basis points off the current federal funds rate target of between 5% and 5.25%. "If the economy continues to grow, the unemployment rate remains below 4%, and underlying inflation comes down only slowly, as we expect … Fed officials are likely to keep rates unchanged at what they view as a restrictive level well into 2024," Hatzius said. The economist added markets "should continue to climb the wall of worry" in coming months. However, he expects upside will be limited by high valuations and a soft-landing scenario that "is still a work in progress" and dependent on multiple factors coming together, not just in the U.S., but in other developed economies as well.