Probability of US recession falls as uncertainty triggered by debt ceiling dissipates

Chances of contraction down from forecast 35% as US banking sector distress having only modest impact on economy

A woman shops for groceries at a supermarket in California. The Federal Reserve is expected to increase interest rates twice more this year to bring inflation close to its target 2 per cent range. AFP
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The probability of a recession in the US over the coming year has dropped to 25 per cent as uncertainty triggered by the disruptive debt ceiling fight has dissipated, according to Goldman Sachs.

The chances of contraction in the world’s biggest economy over the next 12-month period have come down from an earlier projection of 35 per cent as the banking sector distress appears to have only a modest economic impact, the investment bank said in its latest report on the US economy.

Growth in the US is also getting a sizable boost from a recovery in real disposable income and stabilisation in the country’s housing market, Jan Hatzius, chief economist and head of research at Goldman Sachs, said.

Economists at the bank are forecasting annual average growth this year of 1.8 per cent, which is well above the consensus of private-sector economists and projections from the US Federal Reserve.

“A critical question is whether the Fed will have to generate a recession to bring inflation back to its target of 2 per cent,” Mr Hatzius said.

“The key issue to watch is whether the labour market is able to rebalance smoothly. Most of the news in this regard has been positive.”

In June, US President Joe Biden signed a debt ceiling bill passed by Congress after weeks of wrangling to avert a catastrophic, self-induced default.

The Fiscal Responsibility Act of 2023 authorised the government to extend the so-called debt ceiling to renew borrowing and allow the payment of government bills.

In a rare Oval Office address, Mr Biden said that the debt ceiling bill had saved the country from “economic collapse”.

Silicon Valley Bank's collapse in March, which caused a run on other US banks including the failed Signature and First Republic banks, also stoked fears of an imminent recession.

Last month, Federal Reserve Chairman Jerome Powell said the SVB's failure had exposed vulnerabilities in the banking sector and warranted stronger supervision and quicker action from regulators to avert crises and consequences for the economy.

According to Goldman Sachs, the agreement to raise the nation’s debt limit will result in “small spending cuts that are expected to leave the economy’s trajectory unchanged over the next two years”.

The turbulence among regional banks is forecast by Goldman Sachs economists to subtract about 0.4 percentage points from inflation-adjusted GDP growth this year.

The Fed, which has been aggressively increasing interest rates to bring inflation down to its 2 per cent target range, raised the policy rates again in June. It is expected to implement two more increases this year.

Officials at the central bank anticipate the federal funds rate to reach 5.6 per cent this year, up from its previous 5.1 per cent projection.

Mr Powell indicated in May that the country could skirt a downturn despite continued increase in interest rates, but staff at the Fed expect a “mild recession” to begin later this year.

Bank of America is predicting a recession beginning in the third quarter of this year, which could lead the unemployment rate to rise to 4.7 per cent in early 2024.

Deutsche Bank forecasts recession to begin in the final months of this year and unemployment to rise to nearly 5.5 per cent in the second quarter of 2024.

Although non-farm payrolls grew by another 339,000 in May, the unemployment rate in effect edged up slightly to 3.7 per cent due to a decline in self-employment, according to the Goldman Sachs report.

For more than a year, the US economy has found ways of creating large numbers of jobs while keeping the unemployment rate very close to its pre-pandemic level of 3.5 per cent; however, “this cycle is different”, Mr Hatzius said.

While declines in inflation are still falling short of expectations, Goldman Sachs economists said the “deceleration in inflation across a broad range of indicators is now a fact, not just a forecast, and prospects for further progress in the second half of 2023 also look promising”.

The bank forecast core inflation to come down to 3.7 per cent by December this year, with sequential rates averaging 2.9 per cent in the second half of the year.

Goldman Sachs also has “fairly hawkish” views on monetary policy in some of the other English-speaking countries. It recently added a third 25 basis point increase to its Bank of England call and now sees a 5.25 per cent peak rate in the UK.

It has also added two 25bp rate increases in Canada and expects Australia’s interest rate to peak at 4.35 per cent this year.

“The common theme is that while most of the heavy lifting is done, many central banks are finding that they still have a bit more work to do before monetary policy is at an appropriately restrictive setting,” the report said.

Updated: July 04, 2023, 4:44 AM