Markets might be overlooking a crucial 2019 lesson, according to Goldman Sachs.
According to a letter from the Wall Street bank, there won't likely be any
significant new information at the Federal Open Market Committee's (FOMC)
meeting in January. According to its analysts, the statement might recognise
labour market stabilisation, but it is unlikely to provide precise instructions
either the March meeting or the timeline for upcoming rate hikes.
In a note, strategists stated, "We will listen for hints about whether the
further decline in inflation we expect in coming months could open the door to
rate cuts, how strongly the leadership feels that the current level of the
funds rate is still “meaningfully restrictive” and not an appropriate stopping point."
They also want to see how the FOMC intends to deal with the uncertainties
surrounding prospective tariff increases and how they might affect prices.
Goldman Sachs continues to project a positive economic outlook for 2025,
predicting GDP growth that above consensus projections, a small improvement in
labour market conditions after a downturn in 2024, and progress towards the 2%
inflation target.
The bank anticipates a sustained drop in the year-over-year rate in the
upcoming inflation reports. Rate cuts, according to Goldman Sachs, would be
acceptable but not necessary given the economic prospects predicted for this
year.
Goldman Sachs says the Committee's approach to tariffs will have a major role
in the FOMC's choices. According to the bank's base case, tariffs would only
slightly raise inflation by 0.3 percentage points, which might allow for rate
cuts and avoid an inflation spike.
Nevertheless, uncertainty or worries that their actions might be held
accountable for any inflationary effects of tariffs may make FOMC members
reluctant to cut rates.
In order to gain insight into how the FOMC would react to the current
situation, the Wall Street firm has examined transcripts and assessments of Fed
meetings held during the 2018–2019 trade war.
First, the bank discovered that, like Goldman Sachs today, Fed employees and
FOMC members once held a permissive attitude regarding the effect of tariffs on
inflation.
Furthermore, Goldman's estimate of the GDP impact from the higher tariff
proposals was not as accurate as the staff's, which was substantial.
Additionally, some members questioned whether the consequences of tariffs
justified a monetary policy response, even if the FOMC ultimately opted to
lower rates.
Based on the assumption of a strong labour market and a sustained reduction in
inflation, Goldman Sachs projects two rate cuts of 25 basis points each in June
and December of this year, with a further cut expected in 2026.
However, the company notes that because of economic projections and the
uncertainty surrounding the FOMC's tariff policy, it is challenging to foresee
the precise timing of these reduction.
As a probabilistic assessment of potential Fed courses in the upcoming years,
strategists noted, "we are more convinced that market pricing is too
hawkish, and in particular that the market-implied probability of rate hikes is
too high."
They don't think the new administration's policies will cause enough inflation
to have the FOMC think about raising rates from what it now considers to be a
restrictive level.
"We are concerned that the 2019 lesson—in which tariffs caused volatility
in the stock market and helped the FOMC implement "insurance cuts"—is
being overlooked," the researchers said.
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