Goldman’s 2024 US Macro Outlook: Taking A Victory Lap

Every year, around Thanksgiving, investment banks publish their 2024 outlooks where they attempt to predict what the next year will have in store for markets. It’s always a bit of a gamble to prognosticate so far into the future, and the running joke is that most outlooks published around Thanksgiving prove themselves hopelessly wrong before New Years Eve rolls around.

However, on those rare occasions when a bank’s prior outlook proved prescient, the next outlook is sure to be used to remind everyone that they were on the right side of history. This has certainly been true over at Goldman. Because Jan Hatzius – Goldman’s chief economist – went out on a limb last year saying there’s little risk of inflation persisting over the medium-term, and that inflation can and will flutter back down toward target without a recession being necessary.

Hatzius’ predictions were far from consensus – this time last year the consensus across banks was split on whether a recession would occur sometime this year – but his theory for how inflation could deflate while growth remained somewhat robust now looks more right than it does wrong.

So Goldman’s 2024 US Macro Outlook is part prognostication on the future and part well-deserved victory lap. The main report is titled “Final Descent” and that really sums up the view of Goldman at this moment: that the hard part is over, that we’re in the final innings of this inflationary ball game, and that next year will be a bit more boring (less volatile) than this year.

Although as Anshul Sehgal, Head of US Rates Trading at GS, said in a recent desk note what’s looming over everything in 2024 is the election. Plus, if the market consensus becomes that inflation has been defeated, but unemployment begins ticking up further, the Fed’s steadfast commitment to keeping rates higher for longer may start to ring even more hollow to the ears of market participants.

Or, as Schiffrin, Head of Macro Trading, said in a recent desk note: “…I am very open to the idea of a turn weaker in the labor market (or a growth scare) resulting in the [F]ed turning to cuts relatively quickly even if inflation is optically somewhat higher on a [YoY] basis as that weakness would likely give the Fed confidence that inflation will be more likely to return sustainability to 2% and that failing to act would potentially result in more labor weakness and they would focus on their dual mandate.”

Update: This is a bit more of an editorial-style post. But be sure to read the sales and trading interview questions, sales and trading overview, etc. before interviews (although this post has some good talking points that you can use in answering market-based questions).

The Labor Market Rebalancing Is Over

Core to Goldman’s thesis this time last year was that inflation could flutter down to (near) target levels by the end of 2023 without there being a recession – and the way this could occur is through the labor market going through a sizeable rebalancing that didn’t involve the unemployment rate meaningfully ticking up.

To simplify a bit, Goldman thought that the inflation we’ve seen over the past two years could be thought of as being due to three factors: supply-chain disruptions, artificially high demand due to the excess savings that consumers accumulated through the pandemic, and wage inflation. GS thought that the former two would naturally work themselves out of the system this year (i.e., supply-chains would rebalance as the pandemic receded further into the past, and excess savings would be spent down by consumers).

Goldman conceded that if wage inflation stayed at elevated levels due to the incredibly tight labor market of 2021-2022 that would flow through into higher underlying inflation moving forward (it’s hard to argue otherwise!). But, unlike most, they believed that a recession wasn’t needed to get wage inflation down to a level consistent with 2% inflation (there are arguments on what this level is, but most would say wage inflation around ~4% is consistent with 2% inflation).

Goldman told the following story: if economic growth cools a little bit then job openings will fall, then employees will have less bargaining power with their current employer because there are fewer alternative jobs that’d provide them a significant wage increase, then wage inflation will normalize, and then overall inflation will normalize as consumers return to their historical average annual increase in spending power. In other words, the lynchpin of Goldman’s theory is the number of job openings falling –because if employers don’t have to compete with four other employers for an employee, but maybe only one other, then there’s less need for an employer to offer significantly higher pay. This is similar to what we saw in the late 2010s where wage inflation was moderate and overall inflation stayed around target despite the labor market also being very tight.

Now, Goldman’s theory, in totality, seems to have played out according to plan. However, it’s worth noting that the initial ingredient (lower growth in real terms) didn’t play out as exactly they expected (or as anyone else expected). Instead, the US economy has expanded at a surprisingly rapid pace.

But despite this faster than expected growth we have seen the job-workers gap fall, we have seen wage growth fall, and we have seen core PCE (the Fed’s preferred measure of inflation) fall as Goldman illustrates below with a few arrows showing how they believe each of these informs the other...

So despite Goldman getting the outcome right an explanation is needed here because, in theory, relatively robust growth while inflation is still high should have resulted in inflation stabilizing at a somewhat higher level than it is now. In fact, if you had asked Hatzius this time last year how his theory would play out if growth came in at 2.5% he probably would’ve said the same overall script would play out, but we’d be looking at inflation of 1-2% higher than it is today and perhaps a Fed Funds rate that’s 25-50bps higher.

The explanation offered by GS for how inflation has fallen, despite growth remaining more resilient than even they expected, is that there was far greater labor supply in 2023 than expected which helped to drive down the job-workers gap. This enhanced labor supply was likely in response to individuals that were out of the workforce spending down their pandemic savings and beginning to feel the pressure of inflation.

However, this explains why the number of workers increased above expectations, thus compressing the workers side of the job-workers gap, but not why job openings themselves also fell sharply. The explanation for this is that growth may have been more than expected – albeit still cooler compared to 2021-2022 – but fears of a recession (even if one didn’t eventuate) led to employers being more cautious about expanding employment to meet future demand this year due to uncertainty over whether that demand would end up occuring or not (this aligns with the Beige Book where for most of the year employers have been saying that they’re worried about demand softening and are rolling back hiring so they aren’t caught flat footed with bloated payrolls).

The Future of Inflation in 2024

Given Goldman’s theory of how inflation would fall through this year, it won’t be surprising to hear that they anticipate that the hard part is over, inflation won’t rebound, and that we’re now in the “final descent” toward the Fed’s target.

The reason that GS doesn’t anticipate a resurgence in inflationary pressure is two-fold. First, since wage inflation has fallen so much unless the labor market does a 180 and becomes extremely tight again (i.e., job openings heavily increase, many start leaving the workforce voluntarily, etc.) there’s no reason it shouldn’t settle into it’s pre-pandemic average.

Second, inflation expectations (i.e., the expectations individuals have for inflation in the future) have settled back down after brief flare ups in the last two years (the Fed has historically been very worried about inflation expectations rising as an expectation of higher inflation tends to become a self-fulfilling prophecy). The caveat here is that inflation expectations among the general public are still high, although anchored well, and it's really market participants who have lowered their inflation expectations as illustrated below.

In 2024 GS sees much of the same as we’ve seen for the last few months: disinflation coming down the pipeline as a rebalancing in autos, rents, and the labor market persists. All culminating in Core PCE being a touch above target by the end of the year.

In support of the auto and shelter disinflation themes, Goldman points to the sharp increase in new car inventory and dealer incentives (although both are below pre-pandemic levels) and real-time measures of rental inflation that are in the 1-2% range (as we’ve talked about before, shelter inflation is complicated and a lagged measure so the current level of shelter inflation will take time to feed through into official statistics).

Overall, here’s the inflation picture that GS is forecasting for next year. As you can see, it’s quite a bit more boring than in past years: inflation around target, or just above, for most categories and then large deflationary impulses from housing and some core goods (i.e., vehicles).

The Future of Rates in 2024

Given all of this, one could imagine that GS believes that the Fed will declare that their mission has been accomplished and begin to normalize rates within the next few quarters. After all, if inflation is going to continue grinding lower, and there isn’t anticipated to be any turbulence, then keeping nominal rates at such elevated levels is simply making real rates progressively higher – and, ultimately, it’s real rates that are a drag on the economy.

It is the market consensus view that we’ll not only see sizeable cuts made by the Fed through the next year, but that they’ll begin being made in the next few quarters (something that could insert quite a bit of volatility into markets!). Here’s the current consensus view…

Note: The fall in yields last month due to the market’s pivot from anticipating “higher for longer” rates to large cuts in 2024 is the primary reason that financial conditions eased ~90bps over the month of November – the most in the history of Goldman’s financial conditions index that dates all the way back to 1982 (it’s hard to overstate how much of a surprise this easing has been to almost all market participants).

However, once again, Goldman is going out on a limb and bucking market consensus. They are anticipating only one rate cut next year and are anticipating that cut to occur in Q4 of 2024. This isn’t solely due to Goldman believing that the Fed will be reluctant to cut rates because that could cause animal spirits to run amuck (although this is a very real concern and the market mania that’s occurred over the past month will give at least some at the Fed pause about cutting rates lest they push market froth further – remember that most in the Fed are real believers in the wealth effect, so risk assets flying higher isn’t a welcome development).

Goldman’s view is simply that there isn’t going to be a need for the Fed to worry about cutting rates to stimulate otherwise sluggish growth because real GDP will be a little under 2% next year (in other words, slightly below what we’ve seen over the last year but still well above 2024 market consensus growth).

Further, Goldman, unlike some, is anticipating that inflation won’t drop sharply to near target in the next few quarters but rather will gently glide down to around 2.5% by Q4 at which time the Fed will feel comfortable making their first cut (while telling the market that rates will still stay in restrictive territory, but that there’s no need for them to be so restrictive since inflation has fallen so far). With the Fed having made the mistake of waiting too long to raise rates they’ll, in Goldman’s view, be extremely cautious about moving in the opposite direction unless there’s a clear-cut, compelling reason from an employment perspective (as both Schiffrin and Sehgal of Goldman echoed above).

Per Goldman’s forecasts, the level of cuts priced into the market right now only make sense in a recessionary scenario. There’s simply no other reason that the Fed would cut so soon or so much. Especially with the memory of Arthur Burns in the back of everyone’s minds. Put simply: the market is chomping at the bit for cuts, and risk assets are flying higher in response, when there’s no reason to anticipate they’ll be needed to meet the Fed’s dual mandate.

Moving Forward

There’s no doubt that Goldman thinks next year will be a bit more boring than the prior two years: growth will be sluggish but positive, inflation will continue falling a bit each quarter, and we won’t have the fireworks of the Fed’s first rate cut this cycle until Q4.

However, there’s a reason why these outlooks often end up being mocked, and that’s because it’s impossible to really forecast a week or two into the future never mind a full year (in October everyone was worried about yields running much higher due to an “uncontrolled” deficit!).

And this year there are a number of known uncertainties that could throw a wrench into Goldman’s panacea-like view of the US macro landscape. First, election season is now upon us and, if nothing else, we’re sure to have some volatility based on who wins, what’s promised, and what can be delivered (i.e., if fiscal policy becomes tighter, as occurs most often when there’s divided government, then that could lead to equities and rates heading lower in anticipation of lower growth in the years to come).

Second, the last two years have seen some significant geopolitical shocks and these are, by definition, impossible to forecast (or at least their impacts are impossible to forecast). Further, any geopolitical shocks occuring next year are sure to impact the presidential race, so they matter even more than in isolation.

Overall there’s much less divergence in the 2024 outlooks that have been published over the past few weeks than in years past. Goldman, as has been the case for the past two years, is more bullish on both the US and global economy than most everyone else and that’s informing both how many rate cuts will occur and when they will occur. But everyone is still singing a roughly similar tune (i.e., a recession is less likely next year than many thought it was this time last year, inflation is more likely to fall to target than to do an about face and start going higher, and the Fed and most other DM central banks will begin cutting before the end of next year).

Put another way, this time last year we had the prognostications of some (i.e., Barclays and Goldman) pointing in different directions, whereas today everyone is aligned directionally in their views; the only real difference is that of timing and magnitude.