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Goldman sees ‘possible but difficult path’ for Fed to beat inflation without recession


Construction workers outside the Marriner S. Eccles Federal Reserve Building, pictured Wednesday, July 27, 2022 in Washington, DC.

Kent Nishimura | Los Angeles Times | beautiful pictures

According to Goldman Sachs, the Federal Reserve’s path to reducing inflation while keeping the economy from falling into a major recession remains wide but narrowing.

As the central bank looks set to continue raising interest rates, the economy is showing mixed signals: Salary figures increase rapidly against The number of houses fell sharplyPetrol prices fell against higher food and accommodation costs, and consumer sentiment was low relative to steady spending figures.

All in all, the Fed is trying to strike a balance between slowing things down, but not too much.

On that score, Goldman economists say there have been clear wins, some losses, and the landscape ahead poses major challenges.

“Our broad conclusion is that there is a viable but unlikely path to a soft landing, although a number of factors beyond the Fed’s control could ease or complicate that path and increase or reduce the likelihood of success,” Goldman economist David Mericle said in a client note. Sunday.

Slow growth, high inflation

One of the biggest inflation drivers is excessive growth that has created an imbalance between supply and demand. The Fed is using rate hikes to try to reduce demand so supply can catch up and supply chain pressures, as measured by a Fed index in New Yorkis at its lowest level since January 2021.

So on that score, Mericle said the Fed’s efforts “have gone well.” He said the pace of growth – a total of 2.25 percentage points since March – has “gained a much-needed deceleration” related to growth and specifically demand.

In fact, Goldman expects GDP to grow at just 1% over the next four quarters, and that’s happening consecutive declines of 1.6% and 0.9%. Although most economists expect that the National Bureau of Economic Research will not declare America in recession In the first half of the year, the growth path slowed down making the Fed’s balancing act more difficult.

In a similar vein, Mericle said the Fed’s moves have helped narrow the supply-demand gap in the labor market, where there are still almost two job opportunities for every worker available. He wrote.

However, the biggest problem is still high inflation.

The Consumer price index flat in July but still up 8.5% from a year ago. Wages are on the rise, with average hourly earnings up 5.2% from a year ago. As a result, the Fed’s efforts to prevent a spiral in which higher prices drive higher wages and lingering inflation have “shown little convincing progress so far,” Mericle said.

“The bad news is that inflation is broadly high, key trend indicators are up, and business inflation expectations and valuation intentions remain high,” he added.

Doubts about Fed policy

Fighting inflation may require a higher rate hike than the current market anticipates.

Goldman’s prediction is for the Fed to raise its benchmark interest rate by another percentage point before year-end, but Mericle admits there is “rising risk” from “recently easing financial conditions, strong hiring pace.” and signs of struggling wage growth and inflation.”

Indeed, former New York Fed President William Dudley on Monday said he thinks the market is underestimating the path to future rate hikes and, therefore, the risk of a hard landing or recession. withdrawal.

“The market is misinterpreting the Fed’s intentions,” he told CNBC.Squawk . Box“in a face-to-face interview.” I think the Fed will be even higher than market participants understand at this point. “

In Dudley’s view, the Fed will continue to increase until it is certain that inflation returns to the central bank’s 2% target. Even by the most generous measure of inflation, the core personal consumption expenditure price index that the Fed follows, Inflation is still at 4.8%.

“The labor market is much tighter than the Fed wants. Wage inflation is too high, not consistent with 2% inflation,” he added.

Dudley expects rates to continue to rise until employment dynamics change enough for the unemployment rate to stay “4% higher” from its current level of 3.5%.

“Anytime the unemployment rate rises by half a percentage point or more, the result is a full-blown recession,” he said.

A measure of the relationship between unemployment and recession known as the Sahm Rule, which states that a recession occurs when the three-month average unemployment rate rises by half a percentage point from its lowest level in the previous 12 months. there.

So that would only require a rate of 4% according to Sahm’s Rule. In their most recent economic projections, members of the Federal Open Market Committee that set the rate do not see unemployment breaking that rate until 2024.



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