Goldman Sachs is urging the Federal Reserve to be patient in its quest to squash inflation.
Even though inflation remains far too high, the investment bank says the Fed has already made “remarkable” progress in slowing the US economy and easing the concerning imbalance between supply and demand in the jobs market.
This progress comes after the Fed has raised interest rates at the fastest pace in at least four decades, marked by three consecutive rate hikes of three-quarters of a percentage point.
“Fiscal and monetary policy tightening has so far managed to slow demand growth sharply without accidentally overdoing it and sparking a recession, an impressive achievement,” Goldman Sachs economists wrote in a note to clients on Sunday.
For instance, the decline in job openings is twice as large as any decline in US history outside of a recession, the bank said.
That’s why Goldman Sachs said the risk that a recession will prove necessary to tame inflation has “diminished a little.”
However, Fed officials have signaled they are not nearly done with their string of rate hikes, with more expected at both next week’s meeting and the one in December.
Goldman Sachs is cautioning the Fed against overdoing it.
The bank said the risk the Fed raises rates enough to “cause a recession that is not necessary” has “likely increased somewhat.” The main reason for that assessment, Goldman Sachs said, is that it is “increasingly clear” that shelter and health care inflation — two key components of the underlying inflation trend that Fed officials care about — will remain “uncomfortably high throughout 2023” no matter what happens in the jobs market. That’s despite the fact that Goldman Sachs expects inflation to fall “substantially next year.”
“Too great a focus on lagging indicators, too little patience, or tightening too quickly to gauge the impact on the economy in real time could result in a recession that is not entirely intended,” Goldman Sachs said.
In other words, the Fed could sink the economy even though a recession isn’t needed to tame inflation.
Goldman Sachs said it will raise its odds of an unnecessary recession caused by the Fed if officials start to signal ongoing rate hikes of at least half a percentage point are appropriate until inflation comes down meaningfully.
The warning from Goldman Sachs comes as recession predictions continue to pile up. The latest: The Mortgage Bankers Association is now calling for a recession that begins during the first half of next year, driving up the unemployment rate to 5.5% by the end of 2023.
“The sharp increase in interest rates this year — a consequence of the Federal Reserve’s efforts to slow inflation, will lead to an equally sharp slowdown in the economy, matching the downturn that is happening right now in the housing market,” MBA chief economist Mike Fratantoni said in a statement.
A Bloomberg Economics model released last week determined that the risk of a recession over the next 12 months now stands at a staggering 100%.
By contrast, Goldman Sachs is stressing that a downturn is hardly a foregone conclusion. The bank sees a 35% chance of a recession in the next 12 months. Although that is roughly triple the historical average for a typical year, that’s well below the 63% consensus in a recent survey by The Wall Street Journal.
“The US economy is growing well below its long-term potential rate but does not appear to be on the brink of recession at the moment,” Goldman Sachs economists wrote.