In late September of last year, Federal Reserve Chairman Jerome Powell came clean with reporters at a news conference in Washington D.C., admitting that his battle with inflation was going to be more challenging than anticipated and the odds of the soft landing for the economy were likely to diminish. Seven months later, the Fed has abandoned its soft landing forecast altogether. Minutes from the latest Federal Open Market Committee (FOMC) meeting, which took place on March 21 and 22, show the central banks economists expect a recession later this year.
The economists outlook has featured subdued growth and some softening in the labor market for months now, but after the recent banking instability, headlined by the second and third largest bank failures in U.S. history, theyve become even more pessimistic.
Given their assessment of the potential economic effects of the recent banking-sector developments, the staffs projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years, the FOMC minutes summary states.
Despite the bearish forecast from the Fed, Goldman Sachs chief economist and head of Global Investment Research Jan Hatzius said Wednesday after the release of the minutes summary that he still believes the U.S. economy can avoid a recession. Hatzius sees just a 35% of a U.S. recession over the next 12 months. Thats up from the 25% he had forecast prior to the recent bank failures, but still far below Wall Streets 65% consensus and the view of the Feds staff.
Still, some economists contend that even if recent banking stress doesnt push the economy into a recession in the near-term, the Fed will still have to spark one if they want to bring inflation back to their 2% target durably. But do they really?
We dont think so, Hatzius wrote in a Wednesday research note, arguing the latest data has confirmed inflation is still slowing. This is a reassuring development following the upside surprises of early Q1, he added.
To his point, year-over-year inflation, as measured by consumer price index (CPI), fell to 5% in March, and has steadily declined since its 9.1% four-decade high last June. And the Feds favorite inflation gauge, the personal consumption expenditures (PCE) index, sank to 5% in February as well, down from its June high of roughly 7%. Marchs PCE data will be released on April 28.
Hatzius noted that there has also been particularly encouraging news from the labor market recently that gives him faith inflation will continue to fall. For over a year now, the Fed has maintained that the labor market needs to cool in order for inflation to fade, and to ensure that cooling, most economists argue the unemployment rate must rise substantiallybut not Hatzius.
Goldmans chief economist has argued since last year that if the jobs-workers gapthe difference between the total number of jobs and the number of workers in the economynarrows sharply, then that could be enough to reduce inflation to the Feds 2% target without the need for significant job losses.
Last March, when the jobs-workers gap hit a record 5.9 million, Hatzius said it was evidence the U.S. was experiencing its most overheated and unbalanced labor market in the post-war period. He warned that if it persisted, wages would rise and boost inflation, making the Feds job even more difficult. And thats what happened most of last year, but now a new trend has emerged.
The number of available jobs in the U.S. declined to 9.9 million in March from a high of over 12 million last June, according to the latest JOLTS data. Hatzius said this has pushed the jobs-workers gap at least halfway back to its pre-pandemic levels. And he noted that wage growth is also trending towards a 3.5% pace that is consistent with the Feds inflation target.
The good news is all of this labor market cooling is happening while the combination of higher labor force participation and increased immigration has allowed the unemployment rate to remain low near a historic low of 3.5%.
As we noted late last year, this cycle is different from prior high-inflation periods in ways that should continue to make it much easier to bring down inflation without a recession, Hatzius said, noting that labor markets should prove much easier to rebalance via reduced job openings and without a largeor perhaps, anyhit to employment.
While Hatzius doesnt expect a U.S. recession this year, that doesnt mean the economy wont slow. Goldman is forecasting U.S. GDP growth will fall to just 1.3% in 2023. [M]ajor economies need a landing from the post-covid inflation surge, Haztius explained, but we expect it to be mostly soft.
