Why US recession fears are likely overblown

Market Reaction and Labor Data Analysis

• Global markets have sold off significantly following a U.S. jobs report that came in well below expectations, sparking recession fears.
• Goldman Sachs Chief U.S. Economist David Miracle assesses the July report as weak but believes investor fears of a sudden economic shift are overdone.
• Job growth in July was soft in both the Establishment and household surveys, failing to keep pace with labor supply growth.
• The unemployment rate rose by two-tenths, with 70% of the increase attributed to temporary layoffs.
• Temporary factors weighing on the data include a surge in weather-related time off and a large increase in temporary layoffs.
• Miracle notes that jobless claims, job openings, and the rate of permanent layoffs remain robust, with permanent layoffs still at historic lows.
• Approximately 30% of the unemployment increase reflects temporary frictions, specifically job-finding challenges for recent immigrants whose population share has risen.

Economic Growth and Sector Trends

• U.S. real GDP growth is estimated at approximately 2.5% in Q2 and is tracking similarly for Q3.
• Labor demand is not expected to drop abruptly as long as overall economic activity and final demand for goods and services continue to grow.
• Recent softness in ISM manufacturing survey data is attributed to a multi-year bias where high inflation frustration and media narratives skew company sentiment.
• Hard data continues to indicate healthy growth, contrasting with the "recession gloom" reflected in survey data.
• The exceptional job growth and 3% GDP growth seen in 2023 are viewed as unsustainable numbers propped up by the peak of the immigration boom.

Consumer Spending and Earnings Season Sentiment

• Market perceptions of a grim U.S. consumer narrative are driven by anecdotal company messaging during earnings season and weaker survey data.
• Miracle remains skeptical of a broad consumer downturn, citing that aggregate earnings surprises remain positive despite a deceleration in growth rates.
• Negative anecdotes often disproportionately reflect the goods sector, which is in a "goods-back-to-services" transition phase, rather than the resilient services sector.
• Company-level data can be misleading due to year-over-year comparisons, pricing strategies affecting volume, and the conflation of global weakness with U.S. domestic performance.

Recession Probability and Forward-Looking Forecasts

• Goldman Sachs has increased its 12-month U.S. recession probability from 15% to 25% following trends of declining job growth and rising slack.
• The firm maintains recession odds below market consensus, citing the absence of a specific negative shock, growth near potential, and significant Federal Reserve policy flexibility.
• The Federal Reserve currently has 525 basis points of room to cut interest rates to support the economy if data weakens further.
• Goldman Sachs has accelerated its rate cut forecast to expect consecutive cuts in September, November, and December.
• While investors are pricing in a potential 50 basis point cut in September, Goldman's base case expects a 25 basis point cut, assuming August employment data rebounds.
• The firm does not anticipate an emergency Fed cut before the September meeting, noting that historical intermeeting cuts typically follow obvious, immediate crises or sharp spikes in permanent layoffs.
• Current trends are characterized as a deceleration to a healthy growth rate rather than an imminent recession, a shift considered inevitable following the exceptional performance of 2023.

Fed Policy Response Scenarios

• If incoming data reveals significant weakness or if financial tightening risks becoming self-fulfilling, the Federal Reserve is expected to respond forcefully without hesitation.
• The Fed is well-positioned to address potential economic deterioration given that inflation is judged to be essentially solved.
• Larger rate cuts in the past have historically been triggered by clear evidence of rising permanent jobless claims.