Wall Street has had a recession on its mind this spring.
Ever since it became clear that 2022 wouldn’t pan out in the way expected, likely around the time Russian tanks rolled into Ukraine, the looming potential for a recession has been the talk of lower Broadway.
While many top investment banks have argued the U.S. economy will fall into a recession by 2023 as the Federal Reserve raises interest rates to combat inflation, Goldman Sachs has remained on the fence.
In a Monday analyst note, Goldman strategists led by Jan Hatzius said the probability of an economic downturn within the next 24 months is 38%. While that forecast is lower than some of their Wall Street peers, the analysts admitted risks to the outlook have grown over the past month.
“Recession risk has risen,” Hatzius wrote. “The financial health of the private sector may ultimately determine whether policy tightening will tilt the economy into a downturn.”
FED HOPES TO ENGINEER SOFT LANDING, BUT HISTORY SHOWS IT WON’T BE EASY
But there is a bright spot in the economy, according to the Goldman analysts: Strong consumer demand, which could help the Federal Reserve to engineer a so-called soft landing — the elusive sweet spot between curbing demand enough to cool inflation without actually triggering a recession.
The bank’s economists see the odds of a recession at about 15% in the next 12 months, with the odds rising to 35% over the next 24 months.
With inflation above 8% for the first time in forty years, Fed officials say they are laser focused on getting interest rates up.
The Fed wants to try to engineer a soft landing, raising rates enough to cool inflation but not so much as to damage the labor market.
Last week, New York Fed President John Williams said achieving a soft landing would not be easy.
Indicators can also send false signals, the strategists said, such as when assets sell off for reasons other than a recession and then overshoot. Global equity markets have been roiled this year by signs of a hawkish tilt in monetary policy, red-hot inflation and the economic impact from the war in Ukraine, while bond markets have also seen a record rout on fears of higher rates.
Goldman strategists said that while their economists do see recession risks as above average this year, they expect the downturn would likely be mild “as the economy lacks major financial imbalances and labor markets remain strong.”
The main goal of the Fed’s plnned rate hikes is to slow wage growth from its recent 5%-6% pace to at least 4%-4.5%, Goldman said. That would help cool inflation close to the Fed’s 2% target in 2023 and 2024.
The current strong economic momentum also limits the risk of a recession in the near-term, Goldman said.
But Goldman said that it expects the Fed to raise its benchmark rate up to the range of 3- 3.25% before they are able to get inflation under control. This is what raises the odds of a recession, the firm said.