What’s ahead for the U.S. economy?

Current Economic Outlook & Recession Probabilities

• Goldman Sachs maintains a more optimistic view on achieving a "soft landing" than market consensus, lowering its 12-month U.S. recession probability to 25% (down from previous assessments) due to observed labor market rebalancing.
• In contrast, the consensus forecast among other economists places the recession probability at over 60%, a figure largely unchanged from the previous fall.
• The firm's optimism is driven by a decline in the "jobs-to-workers gap" (the difference between labor demand and supply) from approximately 6 million to 3 million, achieved without a rise in the unemployment rate.

Labor Market Dynamics

• The U.S. labor market transitioned from the "most overheated" in history to a rebalancing phase characterized by a drop in job openings and a recovery in labor supply, rather than a spike in unemployment.
• Initial unemployment claims have ticked up, and the layoff rate has risen toward 2019 levels; David Miracle characterizes this as a "one-time level reset" or normalization rather than the start of a negative trend.
• Unemployment is projected to rise slightly only to the extent necessary for market balance, with no expectation of a substantial increase that would trigger a recession.
• A key structural shift noted is that with fewer job openings, companies are less reluctant to let go of underperforming employees, increasing involuntary turnover.

Inflation Trajectory & Fed Policy

• While June FOMC meeting data disappointed regarding the pace of core inflation decline, the inflation outlook has "brightened" due to four specific factors:
  • Shelter Inflation: Leading indicators suggest a significant drop ahead, expected to reduce core CPI by 2 to 2.5 percentage points and core PCE by about 1 percentage point.
  • Wage Growth: Real wage growth has moderated significantly from peaks without a rise in unemployment, suggesting temporary exodus factors have resolved.
  • Supply Chains: Goods supply chains are largely resolved on a flow basis, with auto production returning to pre-pandemic levels, creating deflationary pressure.
  • Inflation Psychology: Consumer and business inflation expectations have moderated, breaking the high-inflation mindset seen in the previous summer.
• Goldman Sachs forecasts Core PCE inflation to reach the high 3s by year-end, low-to-mid 2s by the end of next year, and only reach the Fed's 2% target in 2025.
• Specific price categories (e.g., accountant services, healthcare) are lagging due to contract structures and annual reset cycles, meaning some underlying cost pressures have not yet fully appeared in official data.

Consumer Spending & Real Income

• Real disposable income growth resumed in 2023 (projected at 3–4%) as pandemic transfer payments stabilized and headline inflation slowed to match or fall below wage growth.
• Strong income growth is supported by cost-of-living adjustments (COLA) to Social Security, reduced effective tax rates, and increased interest income on savings.
• The firm views robust consumer spending not as a risk of overheating, but as a necessary counterbalance to potential demand weakness, though they monitor for demand growing faster than supply can accommodate.

Banking Sector Risks

• Recent banking stress is expected to cause a moderate tightening in credit, estimated to shave 0.4 percentage points off GDP growth, but is not considered a recessionary shock.
• Three factors limit the severity of the credit crunch: diversified financial alternatives to local banks, the strength of large banks (some of which gained deposits), and the fact that the largest tightening in lending standards already occurred prior to the recent bank failures.
• While total bank lending volumes have dropped noticeably in weekly H8 reports, borrower surveys indicate conditions have remained stable since February.

Key Risks to the Soft Landing Thesis

• Banking Concentration Risks: Continued tightening of lending standards poses specific risks to small businesses and rural areas reliant on small banks.
• Labor Market Composition: The current trend of rising layoffs could accelerate into a sustained increase in unemployment if labor demand restraint continues.
• Sticky Inflation: Uncertainty remains regarding core services inflation, where wage growth and price-setting mechanisms may prove stickier than projected, potentially raising the cost of disinflation.

Forward-Looking Statements & Timelines

• Goldman Sachs expects the Fed to implement two additional rate hikes this year, diverging from the earlier market expectation of only one.
• The firm notes that while headline inflation faced "easy" decreases due to dropping commodity price spikes, the "harder" work lies in bringing core services inflation down, a process with inherent time lags.
• A "breathing point" for the Fed may occur when inflation reaches 2.5%, at which point officials may feel the crisis has subsided even if the 2% target is not yet met.