The U.S. will probably stick a soft landing next year: the world’s largest economy is forecast to narrowly avoid a recession as inflation fades and unemployment nudges up slightly, according to Goldman Sachs Research.
Our economists say there’s a 35% probability that the U.S. tips into recession over the next year, an estimate that’s well below the median of 65% among forecasters in a Wall Street Journal survey. The U.S. may avoid a downturn in part because data on economic activity is nowhere close to recessionary. GDP grew 2.6% (annualized) in the third quarter, according to an advance report. The country added 261,000 jobs last month.
“There are strong reasons to expect positive growth in coming quarters,” Jan Hatzius, head of Goldman Sachs Research and the firm's chief economist, wrote in the team’s 2023 Outlook. Real personal income (adjusted for inflation) is springing back from the drop during the first half of the year when fiscal tightening and a sharp increase in inflation took their toll. Our economists expect real disposable income to increase to a pace of more than 3% over the next year. Even as financial conditions have tightened and are now subtracting about 2 percentage points from growth, the rise in real income is likely to be the stronger force next year.
The U.S. experience in the 1970s and early 1980s underscores that the shock of central bank tightening to contain inflation can cause a jump in unemployment. This time could be different, in part because overheating in the job market has shown up since the pandemic as an unprecedented increase in job openings rather than in excessive employment.
Openings surged between 2020 and 2021 as employers tried to keep up with the strongest economic recovery on record amid ongoing covid concerns and exceptionally generous unemployment benefits. But employment as a share of the labor force only rose to roughly the pre-pandemic level, not above. Employment relative to the working-age population is still below the pre-pandemic level.
Now the economy is beginning to look much different. Demand is slowing, the pandemic has subsided, unemployment benefits have normalized and the extra savings of the pandemic period is coming down. Our jobs-workers gap — total labor demand minus total labor supply — is coming down quickly. Based on timely job openings measures, Goldman Sachs Research estimates that the jobs-workers gap has declined from a peak of almost 6 million to just over 4 million, nearly half of the way to the 2 million level required to slow wage growth to a rate compatible with the Federal Reserve’s inflation target of 2%.
Unlike other bouts of high inflation, supply chains are normalizing as will housing rental markets — a source of disinflation that wasn’t there during the 1970s. Spending is rotating from goods to services and inventories are rebounding. Expectations for long-term inflation are still well anchored, according to surveys of households and economic forecasters as well as the expectations implied by inflation-protected bonds. The expectations for short-term inflation are still relatively high, but much of this probably reflects the spike in commodity prices and should wane if those prices level off.
The Federal Reserve isn’t likely to turn relatively dovish as inflation abates. Our economists expect inflation-adjusted incomes to recover, which will require the central bank to make sure financial conditions stay tight enough to keep economic growth below potential and to continue rebalancing the labor market. To keep that adjustment going, our economists expect another 125 basis points of Fed rate hikes (up from 100 basis points previously): they forecast the central bank to raise rates by 50 basis points next month, and hike by 25 basis points each in February, March and now also in May. Goldman Sachs Research forecasts the funds rate to peak at 5-5.25%, which is slightly more than the market has priced in.
Our economists don’t expect a rate cut until the second quarter of 2024. That again shows how things are different this time: the first Fed cut in the median hiking cycle has historically come roughly six months after the last hike. “With a resilient labor market and still elevated inflation, we don’t see any rate cuts in 2023 unless the economy enters recession after all,” Hatzius wrote.