Goldman sees a ‘feasible but difficult path’ for the Fed to defeat inflation without a recession

Photographed Wednesday, July 27, 20,22 by Washington, DC, of construction workers at the Marriner-S. Eccles Federal Reserve Building.
Kent Nishimura | Los Angeles Times | Getty Images

Goldman Sachs says that the Federal Reserve has a path for reducing runaway inflation, while keeping the economy in a stable state. It is not yet clear but it is narrowing.

While the central banks looks for ways to raise interest rates, mixed signals are abound in the economy. rapidly rising payroll figuresFor sharply declining housing numbersFalling gasoline prices against surging shelter- and food cost increases, as well as low consumer sentiment to offset steady spending.

The Fed is working to find a middle ground between slowing down and not too slowing them down.

According to Goldman economists, there were clear wins and losses, but the landscape is still challenging.

In a Sunday client note, David Mericle, a Goldman economist stated that while there’s a path that is feasible and difficult to achieve a soft landing (though many factors outside the Fed’s reach can make it more or less possible or increase or decrease the chances of success), the conclusion was broad.

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Inflation high and slow growth

Inflation’s biggest driver has been excessive growth which has led to imbalances between demand and supply. To dampen demand, the Fed uses interest rate rises to reduce supply. Supply chain pressures are measured by a New York Fed indexThey are now at their lowest point since January 2021.

Mericle also said that Fed efforts had “gone well” in this regard. He said the rate increases — totaling 2.25 percentage points since March — have “achieved a much-need deceleration” regarding growth and specifically demand.

Goldman predicts GDP growth of 1% in the fourth quarter, which is actually what’s happening. consecutive declines of 1.6% and 0.9%. Most economists believe that the National Bureau of Economic Research will be successful. will not declare the U.S. in recessionSlow growth makes it more challenging for Fed to balance the economy in the first half.

Mericle also stated that the Fed has helped reduce the gap between supply and demand in the labor markets, which still have a large number of unfilled jobs. nearly two job openingsEvery worker is welcome. This effort has “a long way yet to go,” he said.

But, inflation remains stubbornly high.

The consumer price index was flat in JulyHowever, it rose 8.5% over a year. Average hourly wages are up 5.2% over a year, and wage growth is strong. Mericle stated that the Fed has made little progress in stopping a downward spiral where higher prices lead to higher wages and continue inflation.

“The bad thing is that high inflation has broad-based. Measures of the underlying trend remain elevated. Business inflation expectations and pricing intentions continue to be high.” he said.

Questions about Fed’s policy direction

To combat inflation, higher interest rates might be required than is anticipated by the market.

Goldman predicts that the Fed will increase benchmark rates by another percentage points before the end the year. Mericle, however, acknowledged that there are “upside risks” due to “the recent relaxation in financial conditions”, the strong pace of hiring and signs that inflation and wages remain stubborn.

William Dudley, the former New York Fed president, stated Monday that he believes the market underestimates the path of future rate increases and the risk of hard landings or recessions.

He said that the market misunderstands what Fed does, and spoke to CNBC’s “5”.Squawk BoxInterview. “I think that the Fed will continue to raise interest rates for a longer period of time than market participants currently understand.”

Dudley thinks that the Fed should keep increasing its rates until they are certain inflation has returned to the central banks’ 2% target. The Fed’s core personal consumption expenditures price index, which is the inflation measure that Dudley uses, can be used even with the highest possible inflation. inflation is still running at 4.8%.

“The Fed doesn’t want the labor market tighter. He said that the wage inflation rate was too high and not in line with 2% inflation.

Dudley believes that rates will rise to a point where the employment dynamic shifts enough for the unemployment rate to be “well above” 4%, as opposed to 3.5% currently.

According to him, “When the unemployment rate is higher by half a point or more it has been a recession.”

The Sahm Rule is one measure of how unemployment affects a recession. It states that recessions occur when unemployment’s three-month average rises by half the percentage it had over the past 12 months.

According to the Sahm Rule, this would mean that there is only one rate: a rate equal to 4%. According to their latest economic projections members of Federal Open Market Committee, they don’t expect the unemployment rate to break that rate before 2024.

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