While the Federal Reserve has made progress cooling the economy, there has still been “little convincing progress” in bringing down wage growth and high inflation, according to analysts at Goldman Sachs, who predict that it will remain difficult for the central bank to get surging prices under control without a recession.
Markets have rebounded in recent weeks thanks to growing optimism that inflation may have peaked and the U.S. economy can avoid a recession, but not all experts agree with that rosy outlook.
Analysts at Goldman Sachs led by chief economist Jan Hatzius argue that the Federal Reserve still has a monumental task ahead in bringing down inflation to a normalized level without causing a recession, with a “narrow path to a soft landing.”
The firm notes that GDP growth has slowed to a pace where supply can “catch up” to demand thanks to declining fiscal support and a “much-needed” tightening in financial conditions by the Federal Reserve.
Rebalancing labor market supply and demand, however, is “off to a good start but has a long way to go,” with the firm estimating that although job openings have fallen, the gap between jobs and available workers has only closed by about one-quarter of the amount that is estimated to be necessary for a soft landing.
Additionally, there has been “little convincing progress so far” in bringing down high wage growth and consumer prices, Goldman argues, pointing out that inflation remains “broad-based” as “measures of the underlying trend are elevated.”
The firm worries that it will be difficult to avoid a recession, as the analysts doubt whether the U.S. economy can “afford to rebalance supply and demand gently and gradually without high inflation becoming normalized in the meantime.”
While investor sentiment has improved in recent weeks, “bears point out that inflation remains historically high, valuations are above historical averages with risk to 2023 earnings, and retail investors have yet to have a capitulation moment,” according to Nationwide chief of investment research Mark Hackett. “While we continue to be in a period of confusion, sentiment is shifting rapidly as the markets swing positive.”
What To Watch For:
The Federal Reserve raised interest rates by another 75 basis points at its latest policy meeting in July. Combined with a better-than-expected inflation report for July, that has “made it clear” Fed officials plan to “slow the pace of tightening,” according to Goldman analysts, who predict a 50-basis-point rate hike in September followed by 25-basis-point increases in November and December, respectively.
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