Like many of his Wall Street peers, Goldman Sachs chief economist Jan Hatzius has been rethinking the odds of the U.S. economy falling into recession in 2023. With inflation slowly fading from its four-decade high and the labor market proving its resilience in the face of more than 17 months of aggressive interest rate hikes, he now believes there is just a 15% chance of a U.S. recession within the next year, down from the 35% possibility he forecasted in January.
“The continued positive inflation and labor market news has led us to cut our estimated 12-month U.S. recession probability further,” he wrote to clients Monday, noting that 15% is the average recession probability since World War II.
While Hatzius isn’t the only economist who has become increasingly bullish in 2023, he remains one of the most optimistic on Wall Street. Consensus odds for a U.S. recession over the next 12 months are still nearly the highest they’ve been since COVID struck at 60%. Still, Hatzius expects the economy will continue to grow despite the cooling effect of rising interest rates, with GDP growth averaging 2% through year-end 2024.
The veteran economist may be more optimistic about the post-pandemic U.S. economy than most, but he’s far from a perma-bull. Hatzius made a name for himself with some pretty bearish—and needless to say, prescient—forecasts prior to the Global Financial Crisis in 2007; so when he says a “soft landing” is the most likely outcome for the economy, people pay attention.
Expect a mild economic slowdown, not a recession
Late last year, when most Wall Street forecasters were even more sure than they are now that a recession was inevitable, Hatzius pushed back.
The consensus among his peers was that the Federal Reserve would only be able to tame inflation if its interest rate hikes caused a surge in unemployment that forced businesses to cut prices as demand for their goods and services fell. But Hatzius believed that instead of a rise in the unemployment rate, the Fed’s interest rate hikes could merely spark a drop in the number of job openings in the U.S.—which had surged to a record high during the pandemic—while still helping to control inflation.
Essentially, he argued that a decline in job openings from their record high could cool the economy, without freezing it. And so far, his theory has been correct. Inflation is down and the number of U.S. job openings has fallen from over 12 million in March 2022 to just 8.8 million in July, all while the unemployment rate has remained under 4%.
On Monday, the veteran economist reiterated his forecast that rising rates won’t spark a recession. He said economic growth may decelerate in the fourth quarter due to the resumption of student loan payments and “a near-term hit to housing” from rising mortgage rates, but that slowdown will be “shallow and short-lived” for a few key reasons.
First, solid job and wage growth should increase consumers’ real disposable income—an inflation-adjusted measure of after-tax disposable income—and help spur more spending. Consumer spending makes up roughly 70% of U.S. GDP, so more spending is a big deal.
Hatzius said that he was also “unconcerned” by the slight 0.3-percentage-point increase in the unemployment rate in August to 3.8%, because it was caused by a rising labor force participation rate (i.e., more people entering the workforce), rather than falling payroll growth from businesses (i.e., less hiring). It’s an example of the labor market “rebalancing” after years during which businesses struggled to find sufficient talent, he argued.
Finally, Hatzius pushed back on the idea that interest rate hikes affect the economy with "long and variable lags" that have yet to be felt and will ultimately push the economy toward recession. “In fact, we think that the drag from monetary policy tightening will continue to diminish before vanishing entirely by early 2024,” he wrote.
The end of inflation and interest rate hikes?
Inflation has been a thorn in the side of the Fed for more than two years now, but Hatzius believes the central bank may have defeated its greatest enemy.
Although commodity prices have risen in recent weeks, particularly crude oil prices, Hatzius argued that “underlying inflation may already be near the Fed’s target” of 2%.
He pointed to measures of core inflation, which exclude more volatile food and energy prices, as evidence that the worst of consumer price increases have passed. For example, the trimmed mean personal consumption expenditures (PCE) price index—which focuses only on core goods and services prices and removes both the largest and the smallest price changes before averaging the remaining components—is Hatzius’s “favorite” inflation gauge, and it’s sitting at just 2.4%.
And after Fed Chair Jerome Powell’s speech at the central bank’s Jackson Hole, Wyo., conference in August, Hatzius also believes Fed officials are becoming more dovish.
“Our confidence that the Fed is done raising rates has grown,” he wrote Monday. “We view Chair Powell’s promise at Jackson Hole to ‘proceed carefully’ as a signal that a September hike is off the table and the hurdle for a November hike is significant.”
Still, the economist said he expects “very gradual” interest rate cuts will only start in the second quarter of 2024, because the Fed needs to feel confident that inflation is truly under control. And before investors celebrate the likely end of inflation and rate hikes, Hatzius offered a warning about stocks’ lack of potential this year after the recent artificial-intelligence-led market rally. Even if a recession is avoided, “the bulk of this year’s soft landing and AI rally has probably been realized at this point,” he wrote.
