Convinced that the threat from a banking crisis has largely passed, Goldman Sachs has raised the chances that the U.S. economy can avoid a recession. The firm has cut back its recession probability for the next 12 months to 25%, down from 35% earlier that was caused by worries that a bruising fight in Congress over the U.S. debt ceiling combined with the banking threat would take the economy into contraction. With the debt issue resolved and banking stresses abated, Goldman now sees the path to a continued expansion, albeit a slow one, more clearly. “There are two reasons for this change. First, the tail risk of a disruptive debt ceiling fight has disappeared,” Jan Hatzius, chief economist at Goldman, said in a client note. “Second, and more importantly, we have become more confident in our baseline estimate that the banking stress will subtract only a modest 0.4 [percentage points] from real GDP growth this year, as regional bank stock prices have stabilized, deposit outflows have slowed, lending volumes have held up, and lending surveys point to only limited tightening ahead,” he added. Indeed, a stampede of deposit withdrawals around the early March failure of Silicon Valley Bank have not only subsided but also reversed. Deposits rose $86 billion for the week ended May 24, the second consecutive week of inflows, according to Federal Reserve data . The use of emergency lending vehicles the Fed instituted in the wake of the SVB failure also has stabilized, Some banks continue to take advantage of the Bank Term Funding Program but there has been little discount window borrowing. At the same time, Goldman sees other signs that threats to the economy have abated. “Meanwhile, the economy is getting a sizable boost from the recovery in real disposable income and the stabilization in the housing market,” Hatzius said. “This leaves us with a 2023 growth forecast of 1.8% (annual average), well above both the private-sector consensus and the Fed’s view.” Most economists expect the U.S. will experience at least a mild recession later this year or early in 2024. Interest rate increases from the Fed have resulted in tighter credit conditions at banks, irrespective of the SVB fallout, and worries are growing over how much consumer spending can keep up. A widely followed manufacturing gauge from the Institute for Supply Management has shown the sector in contraction for seven months running, while its service sector counterpart is barely expanding. However, the labor market has held up well, with nonfarm payrolls increasing by 339,000 in May even with a 0.3 percentage point increase in the unemployment rate to 3.7%. Though the no-recession call is contrarian, Goldman isn’t alone, as Morgan Stanley expects a “soft landing” even as its economists see risks tilted to the downside. Hatzius conceded that the Fed is likely to raise rates another quarter percentage point, probably in July, and hold there for “about a year” as inflation remains well above the central bank’s 2% target. From a market perspective, he thinks risk assets like stocks could “continue climbing the wall of worry.” “That said, the high level of valuations on both an absolute and relative basis likely limits the upside, especially if rates continue to grind higher,” Hatzius wrote.
