Goldman Sachs economists warned on Tuesday that the odds of the US economy tumbling into a recession next year are rising as the Federal Reserve ratchets up its fight to cool scorching-hot inflation.
In a new analyst note, the Goldman strategists – led by Jan Hatzius – said they see a 30% probability of recession over the next year, up from 15% previously, and a 25% chance of a recession in 2023 if one is avoided this year. That means there is, in total, a 48% chance of an economic downturn in the next two years.
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“We now see recession risk as higher and more front-loaded,” Hatzius wrote in the note. “The main reasons are that our baseline growth path is now lower and that we are increasingly concerned that the Fed will feel compelled to respond forcefully to high headline inflation and consumer inflation expectations if energy prices rise further, even if activity slows sharply.”
Fed policymakers last week approved a 75-basis point interest rate hike – the first since 1994 – as they race to catch up with runaway inflation, pushing the federal funds target range to 1.5% to 1.75%. Another hike of that magnitude could be on the table in July amid signs of stubbornly high inflation, Chairman Jerome Powell told reporters after the meeting, prompting investors to reassess the economic outlook.
Officials also laid out an aggressive path of rate increases for the remainder of the year. New economic projections released after the two-day meeting showed policymakers expect interest rates to hit 3.4% by the end of 2022, which would be the highest level since 2008.
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Hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending. Mortgage rates are already approaching 6%, the highest since 2008, while some credit card issuers have ratcheted up their rates to 20%.
Still, the Goldman economists argued that despite hot wage growth and high inflation, the outlook is far different from what it was in the 1970s, when the economy was plagued by a phenomenon known as stagflation. Should the economy slide into a recession, the strategists predicted that it would be relatively mild.
“What might a recession look like? With no major imbalances to unwind, a recession caused by moderate overtightening would most likely be shallow, though even shallower recessions have seen the unemployment rate rise by about 2.5 percentage points on average,” they wrote. “One additional concern this time is that the fiscal and monetary policy response might be more limited than usual.”
Although Powell has said the central bank is not trying to induce a recession, he has not ruled out the possibility of a downturn and has admitted the odds of a successful “soft landing” are getting narrower.
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“There’s a path for us to get there,” Powell told reporters at a post-meeting press conference, referring to a soft landing. “It’s not getting easier. It’s getting more challenging.”