What’s ahead for economies and markets in 2023?

Macro Outlook & Recession Probability

• Goldman Sachs assigns a 35% probability to a U.S. recession in 2023, though the baseline forecast predicts no recession and positive growth.
• Global growth slowed sharply in 2022 due to surging inflation, rising interest rates, and geopolitical turmoil, but a "soft landing" is deemed possible.
• The U.S. labor market is considered "overheated" due to 10 million job openings versus 6 million unemployed workers, but this imbalance is expected to correct via declining job openings rather than significant job losses.
• Real disposable income growth is projected to reach 3% to 3.5% in 2023, driven by fiscal normalization ending and headline inflation slowing faster than wage growth.
• The drag from tightening financial conditions is estimated to have peaked, subtracting approximately 2 percentage points from growth as the economy transitions into 2023.

Inflation & Monetary Policy

• Inflation is expected to cool significantly without deep recession due to well-anchored inflation expectations (5-10 year expectations near 3% vs. ~10% in the 1970s) and "inflation freebies" like declining commodity prices and resolving supply chain issues.
• Rent inflation, a key CPI driver, is expected to fall substantially in 2023 as timely measures of rental costs stagnate or decline.
• Goldman Sachs forecasts the Federal Reserve funds rate will rise to 5%–5.25% by the May 2023 meeting, then pause at that level through 2024.
• The Fed is expected to reduce the pace of rate hikes to 25 basis points per meeting, starting with a potential 25 bps increase in February 2023.
• Goldman Sachs' core PCE inflation forecast for year-end 2023 is 3%, which is lower than the Federal Open Market Committee's projection of 3.5%.
• Probability-weighted rate paths suggest the Fed may cut rates in the latter half of 2024, contingent on economic data and potential recession risks.

Bond Market & Yields

• The central case anticipates yields moving slightly higher during 2023 as economic growth holds up and the Fed maintains restrictive rates.
• The peak in longer-dated yields likely occurred in late 2022, and total bond returns are expected to be modestly positive due to high carry and yield offsetting potential capital losses.
• Volatility from rate shocks is expected to diminish, making bonds a more attractive portfolio component compared to 2022.

Equity Market Valuations

• U.S. equities are relatively "rich" compared to other yielding assets; real yields on Treasuries have risen to levels comparable to long-duration equity valuations, creating a binding constraint on upside.
• European and emerging market equities show deeper valuation discounts compared to the U.S., supported by a less pessimistic outlook for those regions.
• The market is not pricing in full recession-level valuation discounts, trading instead at levels consistent with "weak growth" rather than a contraction.
• Upside in U.S. equities is viewed as limited by current starting valuations and tight labor capacity, making a strong bull market difficult to justify from the current baseline.

Global Regional Forecasts

• Europe: The baseline recession forecast has been removed; GDP is expected to show positive growth in 2023, aided by a warmer winter, dropping gas prices, and potential recovery in China.
• Europe Policy: The ECB is projected to raise deposit rates to 3.25% via two 25 bps moves, with the rate hike cycle nearing its end.
• China: China is forecast to record 5.2% GDP growth in 2023 (up from a revised 2022 estimate) following a V-shaped recovery in activity, with 4Q22 likely contracting.
• China Inflation Impact: A Chinese demand rebound is expected to have a limited inflationary impact on global core inflation, as the recovery is primarily service-sector and domestically focused.
• China Structural Risks: Demographic challenges and property market issues remain significant long-term constraints for China despite the near-term cyclical rebound.

Currency Markets

• The U.S. dollar likely peaked in September/October 2023, with a structural trend toward dollar weakness expected as the Fed tightens less aggressively and non-U.S. growth accelerates.
• A combination of European growth resilience, Chinese reopening, and a less hawkish Fed cycle is identified as a traditional driver for dollar depreciation.
• Exchange rates may remain "choppy" in the near term due to ongoing uncertainty regarding the timing and extent of Fed rate cuts.

Risks & Scenarios

• Downside Risk: A 35% chance of recession involves a risk of adverse multiplier effects where job losses accelerate, potentially pushing equity and credit markets to lows seen in summer 2022.
• Downside Impact: If a recession occurs alongside rising inflation, risk assets would face significant pressure; however, Goldman Sachs views the likelihood of a new inflation surge as diminished.
• Upside Scenario: A "friendlier" outlook exists if inflation cools without recession and global growth (Europe/China) outperforms, though U.S. valuation constraints may limit the magnitude of equity upside.
• Data Divergence: Current economic signals are mixed, with hard data (payrolls, GDP) looking robust while business surveys indicate weakness, creating uncertainty around the precise economic path.