It was just three weeks ago that Goldman, having long held a painstakingly upbeat outlook on the US economy for 2019, finally capitulated and trimmed its hawkish forecast for 4 rate hikes in 2019, calling for less than a 50% probability of a rate hike in the March, even as the bank continued to sneers at the market’s current pricing for the funds rate, which now anticipates no full hike in all of 2019.
Not anymore.
In the last economic note for 2018, Goldman chief economist Jan Hatzius says that in light “of the recent FCI tightening [i.e. market turbulence] and weaker US data” the bank has not only slashed its near-term GDP outlook, but taken down its full year rate hike forecast to a paltry 1.2 for all of 2019 (keep in mind, this number was 4 as recently as the start of December), to wit:
We have revised down our US growth forecast for the first half of 2019 from 2.4% to 2%; we continue to expect growth of 1¾% in H2.
To justify its abrupt reversal, Hatzius presents three “strong” reasons why we should expect slower growth in 2019 vs recent years.
- “First, a slowdown is already evident in the numbers. As shown in Exhibit 1, both real GDP and our current activity indicator (CAI) were running at 3½-4% over the summer, but the pace has recently fallen to the 2-2½% range.”
- “Second, the impulses from fiscal policy and financial conditions are turning more negative. In the second half of 2018, fiscal policy contributed nearly ¾pp to growth via lower taxes and higher spending, but this number will gradually diminish to roughly zero by the end of 2019. In addition, financial conditions have turned into a significant headwind and could take more than 1pp off real GDP growth in the first three quarters of 2019. This means that the demand-side case for above-trend growth is weakening significantly.”
- “Third, the economy needs to slow in order to limit the risk of a dangerous overheating down the road. Unemployment is already ¾pp below our 4½% estimate of the rate consistent with a 2% inflation rate in the medium term. And Exhibit 3 shows that a variety of other measures of labor market slack confirm the message of labor market tightness. Given the close correlation between labor market overheating and subsequent recession, Fed officials will want to see a significant slowdown in growth. This means that if financial conditions reverse too much of their recent tightening, Fed officials would likely turn more hawkish to keep growth from rebounding too much.”
Then, in an amusing twist, the bank which was formerly among the most bullish on the US economy notes that “investors have become much more concerned about a possible recession in recent months, as financial conditions have tightened and growth has slowed.” And while Goldman says that it is “still not particularly worried about a recession” admits that a growth slowdown is necessary to “land the plane” – i.e., avoid a hard landing – further adding that “the two key historical risk factors—inflationary overheating and asset market bubbles—remain largely absent”, and while one can argue the first – especially when stripping out the BLS’ infamous hedonic adjustments which make soaring costs of living, tuition and healthcare expenses magically appear flat as a pancake, the fact that the S&P is is up 300% from its all time lows on the back of $16 trillion in artificial central bank liquidity, is hardly convincing that the “asset market bubble is absent.”
In any case, to underscore its point of a low recession risk, Goldman notes that even with the recent deterioration in economic growth and financial conditions, the bank’s model “says that the risk remains relatively limited in the short term” as shown in the chart below, and adds that “looking beyond the model, we think the prospects for a soft landing are better than now widely thought. “
Of course, that’s precisely what other forecasters, specifically Bank of America thought as well… until the bank laid out a chart showing that according to at least one of its models, the odds of a recession in 2019 have soared from less than 30% heading into December, to a whopping 57% as of last week.
One wonders how long it will take Goldman to capitulate – again – and revise its current 12 month recession odds from 10% to well over 50%, as it once again scrambles to catch up with other banks?
And speaking of further slowdowns to the economy, as noted above, the bank has taken a machete to its rate hike forecast, and after expecting 4 hikes in 2019 less than a month ago, has “also made a further downgrade to our funds rate call” with Goldman now seeing only a “probability-weighted 1.2 hikes in all of 2019, from 1.6 hikes previously.”
Here are some more details on why Goldman claims that contrary to what is now conventional wisdom that the Fed’s rate hike cycle is over, the bank disagrees.
On the back of the lower H1 growth profile, we have made some further downward revisions to estimates for the probability of rate hikes in 2019. Not only is a rate hike in Q1 quite unlikely, but our estimates for the probability of hikes in subsequent quarters have also come down to 55% for Q2 (from 65%) and 45% in Q3 (from 55%); we still view the probability of a hike in Q4 as 55%, i.e. slightly more likely than not. We have also slightly raised our probability of rate cuts to 10% in Q3 (from 5%). As shown in Exhibit 9, these probabilities generate an expected value of 1.2 net hikes in 2019, compared with market pricing of zero hikes.
Here, the only thing Goldman is right about is that the market no longer expects any more rate hikes in 2019, while the odds of a rate cut in the Jan 2020 meeting (above 30%) are 5x greater than the odds of a rate hike.
in fact, as the next chart shows, there has been a stunning repricing in the market’s view of central bank regimes with the ECB now seen by the market as fractionally more likely to hike than the Fed in 2019, a remarkable turnaround, especially since the European economy is expected to suffer a similar economic slowdown in the coming year.
Of course, since it would be uncouth for Goldman to side with the market and go from forecasting 4 rate hikes to 0 in three weeks, the bank claims that the Fed will hike further, for four reasons:
- First, the economy is still growing above trend, from a starting point at which the unemployment rate is already 0.7pp below the FOMC’s latest estimate of full employment. To be sure, growth is slowing, “but there are also some good reasons to expect that slowdown to remain relatively moderate.”
- Second, the bank expect inflation to rise above 2% in the latter half of 2019. Wage growth is accelerating, and Goldman still sees a slightly greater than even probability of a further rise in US tariffs next year. Higher inflation would lower the perceived real funds rate and probably help persuade Fed officials to resume hiking.
- Third, the level of the funds rate is still relatively low. As Chairman Powell noted in the December 19 FOMC press conference, the current 2¼-2½% target range only touches the bottom end of the 2½-3½% range of neutral rate estimates submitted by FOMC participants, and it is well below the levels implied by virtually any form of the well-known Taylor rule.
- Fourth, Goldman expects the FOMC to resist the demands from President Trump for easier monetary policy, and to remain firmly focused on the data and the economic outlook. As Hatzius adds, “although the pressure from the White House contrasts with the hands-off approach taken by the last three presidents, it is far from unprecedented on a longer-term comparison. And in many (though not all) cases, Fed officials ultimately decided to withstand the pressure and focus on their longer-term mandate rather than near-term expediency.”
Considering Goldman’s track record (we have’t forgotten the bank’s calls to keep buying oil in October and November all the way lower, and lower, and lower as WTI crude plunged 28% in Q4, its worst drop since the historic fourth quarter of 2014, which Goldman’s commodity “experts” blamed on “negative convexity“, we look forward Hatzius note – due in about four weeks – laying out four reasons why his four reasons why the Fed will hike in 2019 were all wrong.
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