After more than two years of collective hand-wringing on Wall Street over the possibility that the U.S. economy could tank at a moment’s notice, Goldman Sachs has news: There’s no better chance now of a recession than there is under any other normal circumstances. The bank’s economists over the weekend lowered their recession probability to just 15%, which chief economist Jan Hatzius classified as the “unconditional long-term average.” September’s smashing nonfarm payrolls surge of 254,000 and a downward move in the unemployment rate served as a catalyst for the firm to nearly abandon the chance of a contraction. Heading into the Labor Department count, an upward drift in the unemployment rate had raised concerns that just as inflation was easing, a softening labor market was posing a larger threat. “With nonfarm payroll growth of 254k surprising sharply to the upside, prior months revised higher, and household employment also solid, we now estimate an underlying jobs trend of 196k, well above our pre-payrolls estimate of 140k and modestly above our estimated ‘breakeven rate’ of 150-180k,” Hatzius wrote in a client note. “The upshot is that the fundamental upward pressure on the unemployment rate may have ended via a combination of stronger labor demand growth and weaker labor supply growth (because of slowing immigration),” he added. The move comes at an important time as the Federal Reserve contemplates its next moves in monetary policy. Prior to the report, traders had been betting that the Fed might repeat its 50 basis point — half percentage point — interest rate cut from September before the end of the year. But expectations have swung now, and Goldman concurs with market pricing that the “next few meetings” will see 25 basis point moves. “If Fed officials had known the subsequent data, they probably would have opted for a 25bp cut on September 18. But that doesn’t mean the 50bp cut was a mistake,” Hatzius said, adding that the Fed was “late to start” cutting so the larger move brings the fed funds rate closer to policy rules about where things should stand given the current economic conditions. Getting the calculus right is important from both the market’s and the Fed’s perspective. Despite anticipation for a slower pace of reductions in the near term, futures traders are still pricing in a fed funds rate in the 3.25%-3.5% range by the end of 2025, according to the CME Group’s FedWatch gauge. That’s about 1.5 percentage points lower than the current level and 2 full percentage points below the pre-September cut. However, if Goldman is right and the soft-landing scenario is likely, that kind of rate-slashing is unlikely and more consistent with recessions, not ongoing expansions. History suggests the Fed only cuts 125 basis points in total absent an economic downturn, said Lisa Shallett, chief investment officer at Morgan Stanley. Current market pricing for easing in monetary policy, then, could be overly ambitious. “Something’s gotta give,” Shallett said in a note, “and both stocks and bonds could be vulnerable if expectations are disappointed.”
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