Report: Goldman Sachs —— The US Economy Is Expected to Achieve a Soft Landing in 2023

[TL; DR]

- Looking forward to 2023, the global inflationary pressure is expected to continue.

- The Federal Reserve has raised interest rates significantly to curb inflation, which has achieved initial results.

- Although the consensus of the Federal Reserve is slightly biased towards a hawkish tone, the probability of economic recession in the United States is low.

- However, Goldman Sachs believes that the global economic outlook is still fraught with huge risks and needs to be cautiously optimistic.


Introduction

Since 2022, due to the weakening of the impetus of re-opening, the decline of real disposable income, and the active monetary tightening, the US economic growth has slowed down to a potential speed of less than 1%. However, Goldman Sachs predicts that the economic growth in 2023 will remain roughly at this level and is expected to achieve a soft landing.


Inflation Risk

The IFF 2022 Global Finance and Development Report shows that global economic growth slowed significantly this year due to the impact of multiple factors such as the rapid rise of inflation, the shift in monetary policy in developed countries, the repeated COVID-19 pandemic in some regions, and the continued global supply-side bottlenecks. Looking forward to 2023, the inflationary pressure is expected to continue, and the tightening of global financial conditions may lead to more developing economies in debt distress.

Nevertheless, many economic experts generally believe that global systemic financial risks will not occur in the short term, and the United States can also avoid stagflation risks to some extent.

The growth of the US GDP is expected to slow down from 5.7% in Q4 2021 to only 0.2% in 2022, which means that the policy tightening has been verified so far to prevent the economy from falling into recession.


Since Q2 2022, due to the weakening of the driving force of re-opening, the decline of real disposable income, and the active monetary tightening, the US economic growth has slowed down to a potential speed of less than 1%. Goldman Sachs predicts that the growth in 2023 will remain roughly at this level.

Goldman Sachs stated that many changes had taken place in 2022. The Federal Reserve raised interest rates sharply to curb inflation, pushing the cost of capital of American companies from almost zero to the highest level in a decade. This has translated into a decline in valuation, especially for growth stocks, whose earnings are expected to further reflect the negative impact of the companies with high capital costs in the future. Goldman Sachs Research predicts that the weighted average cost of capital of American companies will remain high by 2023.

It can be observed from the chart that the overheating of the U.S. labor market after the pandemic is not manifested in excessive employment, but in unprecedented job vacancies. However, the proportion of employment in the labor force has recovered to the pre-pandemic level.


For the elasticity of the labor market, the inflation rate is still rising. Unless the economy enters recession, Goldman Sachs predicts that it will not see any interest rate cut in 2023. Therefore, in the non-recession forecast, Goldman Sachs predicted that the Federal Reserve would only implement the first modest 25 basis points interest rate cut in the second quarter of 2024.


However, demand has slowed down, the COVID-19 pandemic has subsided, unemployment benefits have been normalized, and excess savings are decreasing. Job vacancies and staff gaps are rapidly declining.

Goldman Sachs estimates that the employment gap has fallen from a peak of nearly 6 million to just over 4 million. This is partly due to the narrowing of the gap between jobs and workers. Presently, nominal wage growth has slowed to a level consistent with 4.25% wage growth.

By the end of 2023, the core PCE (personal consumption expenditure) inflation rate will drop from 5.1% in September to 2.9% in December 2023. Goldman Sachs estimates that durable goods with limited supply and still high-profit margins, such as second-hand cars, will drive nearly half of the overall core inflation slowdown.

Why does core inflation decrease so much when the unemployment rate increases so little?

Goldman Sachs believes that the reason is that the cycle we are going through is different from the previously high inflation cycle.

First of all, the overheated labor market after the pandemic is not characterized by excessive employment, but by unprecedented job vacancies, which are much easier to fill than to meet the overheated market demand.

Secondly, the normalization of the supply chain and rental housing market in the near future will restrain inflation for a long time.
Third, long-term inflation expectations remain stable.


The Possibility of Recession

The latest economic data of the United States has brought some relief to investors: the labor market is still strong, and the unemployment rate fell to a historical low of 3.7% last month; There are signs that inflation is also easing. Last month, the US CPI increased by 7.7% year-on-year, the lowest level since January this year.

Goldman Sachs expects that FOMC will slow down the pace of interest rate hikes and turn to fine-tune interest rates to maintain economic growth, but will eventually provide more funds to add to the market than expected. Although the consensus of the Federal Reserve is slightly biased towards a hawkish tone, the probability of economic recession in the United States is low, and it is expected that the growing demand next year will be more flexible than expected.

Goldman Sachs estimates that the Federal Reserve will further raise interest rates by 125 basis points to a peak of 5-5.25%, and will not cut interest rates in 2023, in order to maintain growth below the potential level when real income growth is strong.

In the early morning of Thursday, December 14, the Federal Reserve announced its latest interest rate resolution. The members unanimously agreed to raise interest rates by 50 basis points to 4.25% - 4.5% and said that it might be appropriate to continue to raise interest rates. They did not consider cutting interest rates until they were convinced that inflation would continue to decline.

The Federal Reserve will raise the future inflation consensus, the future interest rate level, the terminal interest rate to 5.1%, and the GDP growth forecast for the next two years. It is estimated that the GDP growth rate of the United States next year will be only 0.5%.

Federal Reserve Chairman Powell stated that the level of the terminal interest rate is more important. He did not rule out continuing to raise the peak interest rate forecast, and did not consider changing the inflation target. The path to achieving a "soft landing" is narrow, but it is still possible. The scale of the next interest rate increase will depend on future data and the job market.

After the announcement of the interest rate hike, spot gold plunged $14 in a short time, briefly falling below the $1800 mark, and then returned to above $1810 again. It fell back after Powell‘s speech, and finally closed 0.18% lower at $1807.44/ounce. Spot silver fell below the $24 mark and closed 0.88% higher at $23.94/ounce.

The US stock market opened lower and moved higher. With the hawkish tone of the Federal Reserve and Powell's speech, the US stock market fell rapidly in the middle of the day and maintained its decline at the end of the day. The Dow closed 0.42% lower, the Nasdaq closed 0.76% lower, and the S&P 500 closed 0.61% lower.

According to Bitpush terminal data, BTC briefly fell below $18,000 from $18,355 before the announcement of the interest rate hike resolution, with a current drop of 0.1% and the price of $17,802; ETH's dropped 1.2% subsequently, and its current price is $1,305.

In terms of the dollar index, it rose to 104.2 immediately after the resolution was issued, but then fell below 104 again, closing down 0.36% at 103.62. Non-dollar currencies generally rose again after a short decline. The euro stood at a six-month high of 1.068 against the US dollar, the pound stood at 1.24 against the US dollar, and the US dollar once fell below 135 against the Japanese yen.

As of the time of writing, it is expected that the Federal Reserve will reach the terminal interest rate of 4.86% in May next year. There is a 25% probability to increase interest rates by 50BP in February, and there is room for a 50BP interest rate reduction by the end of next year, which is 80BP different from the 5.1% guidance of the Federal Reserve.

In response, Brian Deese, director of the White House National Economic Commission, said that inflation was still "unacceptably high".


Prediction

The Federal Reserve has begun to slow down the pace of interest rate increase before 2023, but will extend its interest rate increase cycle. In the process, the US economy showed "sustained resilience", and could avoid falling into an overall recession. In view of the fact that the Fed's interest rate raising cycle has not yet ended, there is still a 35% probability of recession in the next 12 months.

However, regardless of whether the United States will eventually experience an economic recession, many investors said that they had reached a consensus on one thing - the market may remain volatile for some time.

On December 14, the November CPI data released by the U.S. Bureau of Labor Statistics was released. The year-on-year growth slowed to 7.1%, which was lower than the expectation of all Wall Street investment banks. It was the smallest growth since December 2021, with a previous value of 7.7%.

Excluding the volatile energy and food prices, the core CPI rose by 6% year-on-year in November, easing from the 6.3% growth in October and also lower than the expected 6.1%. No matter from which perspective, the data clearly shows the downward trend of inflation, and the Federal Reserve's interest rate increase works.

After the data was released, traders updated their expectations of the Federal Reserve's interest rate hike plan. Interest rate traders predicted that the rate hike of the Fed would be reduced to 25 basis points as early as February next year. The traders also expect that the interest rate will exceed the US inflation rate as early as March next year when the CPI will reach about 4.4% and the benchmark interest rate will be 4.8%. From the historical data, the premise for inflation to be finally controlled is that the inflation rate must be lower than the interest rate level. The Federal Reserve is expected to end its tightening cycle in May next year to prepare for the final policy shift.

Goldman Sachs believes that there are several reasons to keep raising interest rates until the spring of 2023:

First, inflation trends may remain uncomfortably high for some time.

Second, as most of the fiscal tightening policy has now passed, and the real disposable income of households has risen again, FOMC will continue to raise interest rates in the spring of 2023. With the income rising again, FOMC will need to tighten policies to keep the economy at a stable and lower-than-expected level.

Goldman Sachs does not expect to cut interest rates next year, and is skeptical that the decline in the inflation rate will cause FOMC to cut interest rates in a neutral direction.

If the inflation rate decreases, the more natural path is to simply wait until problems occur, and then provide small-scale cuts to deal with smaller threats, similar to 2019, or make significant cuts in response to the overall recession.

The analysis of the possible path of the Fed's policy means that the Goldman Sachs probability-weighted model will be more hawkish. If inflation is faster than we expected, or the potential growth momentum is stronger, FOMC may raise the capital interest rate to a higher level.


Conclusion

To sum up, Goldman Sachs estimates that the probability of the U.S. economy entering a recession in the next 12 months is 35%, far below the median of 65% predicted in the latest survey of the Wall Street Journal.

The key economic issue in 2023 is how to avoid a deep recession and reduce the inflation rate to a more acceptable level. Goldman Sachs is optimistic about this, but it also suggests that in the face of the general pressure of inflation, if we pay too much attention to the lagging inflation indicators, the tightening policy will make the economic recession inevitable.

In addition to core inflation dynamics, Goldman Sachs still focuses on political and geopolitical shocks, which may affect the global economy through higher uncertainty, tighter financial conditions, or negative impacts on commodity supply. The Russia-Ukraine war seems to have not been resolved. The impact of the price ceiling on Russian oil is still uncertain. In addition, the political instability in the Middle East may cause greater damage to the energy market.

To sum up, Goldman Sachs believes that the global economic outlook is still fraught with huge risks and needs to be cautiously optimistic.


Disclaimer
Author: David Mericle, Goldman Sachs
Editor: Gate.io Researcher Byron B.
*This article represents only the views of the researcher and does not constitute any investment suggestions.