The Federal Reserve is locked in a battle against inflation, and the effects of its policies increase the chances of a recession. But the outcome for the US economy is far from certain.
Economists use a plane analogy to describe what the US is facing, saying the Fed is trying to slowly turn off the engine of the economy, reducing inflation and ensuring a ‘soft landing’ .
Some even argue that the Fed faces an impossible task in its fight against inflation and that a “hard landing,” also known as a recession, is inevitable.
But Jan Hatzius, chief economist at Goldman Sachs, said in a research note on Monday that he believed a soft landing was still possible, even if the flight path was bumpy.
Hatzius argues that the U.S. economy can avoid the worst economic outcome if it experiences 1) “below-trend” growth, 2) “labour market rebalancing” that involves rising unemployment, and 3) a substantial decline. of inflation.
While Goldman economists still argue there’s a one-in-three chance of a mild U.S. recession within the next year, Hatzius said on Monday he saw “encouraging signs” that the economy is recovering. directs towards these three goals – and a soft landing.
Go in the right direction
First, there is growing evidence that inflationary pressures are easing, particularly in commodity prices. And that trend is set to continue, Hatzius said.
“The sharp drop in commodity prices, a stronger dollar and big improvements in supply chain disruptions all suggest that goods price inflation will continue to decline,” he wrote.
Second, US economic growth is in the midst of a “slowdown” that is critical to reducing inflation. Hatzius noted that the Fed’s interest rate hikes have pushed the average 30-year fixed mortgage rate in the United States above 6%, which should help reduce spending and, therefore, prices. to consumption.
“All in all, we remain comfortable with our forecast that US growth will remain well below trend over the next year,” Hatzius wrote.
Finally, Hatzius noted that the labor market was starting to cool. The number of jobs available per worker, also known as the jobs-workers gap, has fallen by 700,000 in the past four months, and real wage growth is slowing.
This is “encouraging” news for the Fed’s fight against inflation, according to the economist, as the “supply-demand balance” in the labor market begins to improve.
If these signals continue to move in the right direction, it could allow the Fed to slow the pace of its interest rate hikes, or even halt them altogether, boosting the economy and asset prices.
Stand out from the crowd
Hatzius’ view that a soft landing is still possible sets him on the fringes of the investment banking world.
Many major investment banks say a recession is now the most likely outcome for the US economy. And some have gone further, making a US recession their “baseline scenario” over the next 12 months.
Deutsche Bank, for example, has argued since April that a “major” recession is inevitable in the United States and Bank of America said in July that it now suspected a “mild recession” to come this year.
Scott Wren, senior global market strategist at Wells Fargo, also wrote in an Aug. 31 research note that the Fed’s tough stance against inflation, which was underscored by Chairman Jerome Powell’s hawkish comments during the the Fed’s annual conference in Jackson Hole, Wyo., last week – will eventually trigger a recession.
“Fed stakeholders say they are more than willing to give up a good degree of economic growth in order to bring down inflation. We believe this will likely lead to a recession and higher unemployment,” he wrote.
Nomura’s senior U.S. economist, Rob Dent, also said in a research note on Friday that he expects a recession to begin in the fourth quarter of this year as “entrenched inflation” will force the Fed to continue to raise rates even if the economy weakens.
And UBS’s tool to determine the probability of a recession in the United States, which is based on three economic models – a model of hard economic data that takes into account hard results like the unemployment rate and sales at retail, a model that tracks the U.S. Treasury yield curve, and a model based on available corporate credit data – also shows an impending downturn. Over the summer, the probability of a recession based on these three models increased by 20 percentage points to 60%.
Yet Hatzius is far from the only Wall Street economist to argue that a recession is not guaranteed.
“I can foresee ways the economy could still muddle through and avoid a recession over the next year,” said Bill Adams, chief economist at LPL Financial. Fortune Last week.
Adams said if commodity prices decline significantly from their recent highs, the Fed may be able to slow the pace of its interest rate hikes over the next few quarters, allowing for a soft landing.
However, he noted that “the path to this outcome is much narrower than it seemed six months ago.”
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