June 29, 2022 |
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THE RECESSION QUESTION
July 5, 2022 | 5 Minute Read
John Tousley
Global Head of Market Strategy, Strategic Advisory Solutions
John Tousley
The current Federal Reserve (Fed) hiking cycle comes amid a historically tight labor market, an inflation overshoot, and an equity market drawdown, inviting recessionary concerns. While US growth may skew to the downside, our base case does not include a recession in the near future. We believe the Fed can engineer a soft landing—or a healthy growth deceleration without a US recession. In our view, private sector balances remain healthy, growth momentum trumps weak sentiment, and a rotation toward services spending will support consumption, all of which may provide the Fed room to maneuver through economic uncertainty. Even if a recession were to occur, we would enter such a period with unprecedented macro cushioning.
1. Healthy Private Sector Balances
Private sector balance sheets generally remain healthy across broad swaths of the economy, particularly within small businesses, large corporations, the banking system, and households. Across business sectors, strong consumer demand and high output prices have helped prop up financial surpluses even as fiscal support has wound down. As a result, the ability of businesses to finance current levels of investments has maintained near long-term averages. Similarly, the banking system has remained well-liquefied—regulatory capital ratios are at an all-time high and loan-to-deposit ratios are near record lows. Finally, US household net worth has benefited from a three trillion-dollar build-up of excess savings (Exhibit 1), creating substantial macro buffer against tightening financial conditions.
Exhibit 1: Household Net Worth Near All-Time Highs
US Household Net Worth (% of Disposable Personal Income)
Source: Goldman Sachs Global Investment Research. As of June 16, 2022. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document.
2. Growth Outlook Resilience
Declining business confidence and consumer sentiment have historically preceded economic downturns, and the reality of rising recession risk should not be minimized. Still, we think growth momentum trumps sentiment. With the odds in favor of still above-potential GDP growth this year, we believe Fed action will be met with substantial room to moderate aggregate demand, normalize labor demand, and ultimately lower inflation without inducing second-round economic effects. We expect businesses and consumers to offer additional buffers for the Fed to carefully tighten financial conditions. On business activity, Goldman Sachs Global Investment Research forecasts net increases for revenue (+1.1%) and capital expenditures (+1.3%) for the full year. On consumers, we believe that weak consumer sentiment may not spell weak consumption, as a drawdown in the personal savings rate should support current consumption levels.
3. A Goods-to-Services Rotation Boost
Consumers are the engine of the US economy, and we expect a resumption of in-person activity to drive a goods-to-services rotation with important implications. First, virus-sensitive sectors may see a spending rebound of +5% toward pre-pandemic trend (Exhibit 2), re-boosting consumption and GDP growth. Second, a rebound in services spending may help ease goods-induced pressure on supply chains and commodity prices, allowing imbalances to correct with time. Lastly, services normalization may also be met with more labor supply. Our expectation for another million workers to return to the labor force in the next year would support moderation of both wage growth and inflationary pressure.
Exhibit 2: A Reversion to the Trend
Real Goods Consumption and Real Services Consumption (% of 2022 Real GDP)
Source: Goldman Sachs Global Investment Research. As of May 30, 2022.
To be sure, the path for the Fed to achieve a soft landing remains narrow. But, we believe these macro offsets will ease both the severity and duration of any economic contraction.
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