US Recession Risk Eases; Goldman Sachs Expects ‘Confident’ Fed to Cut Rates by 25bps in September

Goldman Sachs economists have lowered their forecast for the likelihood of a U.S. recession within the next 12 months from 25% to 20%, based on recent economic data that does not indicate an impending downturn.

Following July’s jobs report, which raised concerns under the “Sahm rule,” the firm had previously increased its recession estimate from 15% to 25%. This figure was approximately halfway between the historical average of 15%—reflecting a recession occurring roughly every seven years—and the 35% projection made during the early 2023 banking turmoil.

Recent economic indicators prompted a reevaluation. Notably, the nonmanufacturing ISM index for July saw a rebound, with its employment component showing expansion for the first time since November. Additionally, July retail sales exceeded expectations, indicating robust real consumption growth. Initial jobless claims have also decreased over the past two weeks, suggesting earlier increases were partly due to weather and seasonality effects. Furthermore, the Financial Conditions Index (FCI) has softened since the payroll report.

Economists noted, “When recession strikes, it usually strikes quickly,” emphasizing that the recent positive news regarding economic activity, layoffs, and financial conditions warrants careful consideration in relation to whether the July jobs report signaled the beginning of a recession or was merely an isolated weak data point.

They also pointed out that if the U.S. maintains its current growth trajectory, it may start to align more closely with other G10 economies, where the Sahm rule has been less predictive and has held true in less than 70% of instances. Countries like Canada, Sweden, Norway, and New Zealand have experienced significant rises in unemployment without entering a recession.

Looking forward, Goldman Sachs economists stated that if the upcoming August jobs report, scheduled for release on September 6, shows encouraging results, they may revert their recession probability back to 15%.

On the monetary policy front, economists express greater confidence in a projected 25-basis-point rate cut during the September 17-18 Federal Open Market Committee meeting. However, they caution that a 50-basis-point reduction could be considered if the jobs report falls short of expectations. They believe that “with inflation remaining mild and the labor market fully rebalanced, the current policy rate of 5.25%-5.5%—the highest among G10 countries—seems excessive.”

Nonetheless, they emphasize that the existing federal funds rate is less critical for financial conditions than the projected medium-term path suggested by financial markets. They propose that the Federal Reserve could achieve similar accommodative effects through a series of smaller rate cuts instead of one larger cut.