Why a US recession has become less likely

The probability of a U.S. recession in the coming year has declined, as the risk of a disruptive debt-ceiling fight has disappeared and stress in the banking sector appears to be only a modest drag on the economy, according to Goldman Sachs Research.

Our economists say there’s a 25% chance of recession in the next 12 months, down from their earlier projection of 35% shortly following the failure of Silicon Valley Bank in March. The U.S.’s agreement to raise the nation’s debt limit will result in small spending cuts that are expected to leave the economy’s trajectory unchanged over the next two years, while turbulence among regional banks is forecast by Goldman Sachs Research to subtract about 0.4 percentage points from real (inflation adjusted) GDP growth this year.

Growth in the U.S. is also getting a sizable boost from a recovery in real disposable income and stabilization in the housing market, Jan Hatzius, head of Goldman Sachs Research and the firm’s chief economist, writes in the team’s report. Our economists forecast annual average growth this year of 1.8%, which is well above the consensus of private-sector economists and projections from the U.S. Federal Reserve.

A critical question is whether the Fed will have to generate a recession to bring inflation back to its target of 2%: The key issue to watch is whether the labor market is able to rebalance smoothly, according to Goldman Sachs Research. “Most of the news in this regard has been positive,” Hatzius writes.

Although nonfarm payrolls grew another whopping 339,000 in May, the unemployment rate actually edged up slightly to 3.7% because of a decline in self-employment. For more than a year, the U.S. economy has found ways of creating large numbers of jobs while keeping the unemployment rate very close to its pre-pandemic level of 3.5%. “Once again, we note that this cycle is different,” Hatzius writes.

Broader measures of labor market overheating, meanwhile, continue to improve.

• While the Job Openings and Labor Turnover Survey (JOLTS) showed a surprise increase to 10.1 million in April, the private-sector measures from LinkUp and Indeed declined further in April and May.
• The quits rate has returned to the top end of the pre-pandemic range.
• The share of Russell 3000 earnings calls that mentioned labor shortages fell further to 3% in the first quarter of 2023, relative to a peak of 16.5% in the third quarter of 2021.
• Both average hourly earnings and our economists’ revamped sequential wage tracker have continued to trend down (albeit more slowly than in 2022).
• Each of our economists’ preferred measures of labor market balance has now reversed significantly more than half of its post-pandemic overshoot, but most still have some way to go before they are consistent with 2% inflation.

While declines in inflation are still falling short of expectations, our economists point out that deceleration in inflation across a broad range of indicators is now a fact, not just a forecast, and prospects for further progress in the second half of 2023 also look promising. They forecast core PCE inflation to come down to 3.7% by December 2023, with sequential rates averaging 2.9% in the second half of the year.

They expect improving supply chains and declining used-car auction prices to bring down core goods inflation materially starting in June, following what is likely to be another used car price increase in the Consumer Price Index in May. Our economists also think the news on rent inflation remains encouraging, with signs that seasonally adjusted asking rents fell in May despite the rebound in house prices. And the rebalancing in the labor market should bring down core service inflation excluding shelter (although they expect progress to remain only gradual when it comes to shelter inflation).