The Fed is likely finished hiking rates as the US avoids recession

Episode Summary

Executive Summary: Goldman Sachs chief U.S. economist David Mericle argues the Fed is likely done hiking after July 2023, with Jackson Hole signaling a pause and cuts more likely starting in Q2 2024 if inflation cools further. He sees a soft landing as the base case: labor markets have rebalanced, inflation should keep easing, and recession risk has fallen meaningfully.

Main Topics: Fed outlook after Jackson Hole (Priority: 5/5): Mericle says Powell’s reintroduction of the word “carefully” suggests the Fed is very unlikely to hike in September and that July’s hike may be the last in the cycle. Why the economy remains resilient (Priority: 5/5): Despite tighter policy and higher rates, demand and GDP have held up because supply has improved through higher labor force participation, immigration, and post-pandemic normalization. Inflation disinflation path (Priority: 5/5): Inflation is still above target, but labor market rebalancing, easing shortages, and fading pandemic distortions should continue to push core inflation lower over time. Impact of higher rates on growth (Priority: 4/5): Most growth drag from tightening is believed to be behind us, though some additional effects may still emerge from bank credit, refinancing pressure, and housing. Timing and pace of rate cuts (Priority: 4/5): The base case is first cuts in Q2 2024 at a cautious pace of 25 bps per quarter, with the policy rate likely normalizing only to the low threes rather than the dot plot’s long-run 2.5%. Recession risk and residual vulnerabilities (Priority: 4/5): Goldman cut its 12-month recession probability to 15%, but still flags risks from slowing labor markets, student loan repayments, and weak, chronically unprofitable firms.

Key Arguments: Powell’s use of “carefully” at Jackson Hole implies the Fed is likely to hold rates steady in September rather than resume hikes. The July 2023 hike is expected to be the last because labor market rebalancing is already close to levels consistent with 2% inflation. Strong GDP growth is not necessarily a problem if it is accompanied by continued supply-side improvement and cooling inflation. Inflation should continue to normalize as labor market tightness eases, inflation expectations remain anchored, and pandemic-related price distortions fade. Energy price increases are now a mild annoyance rather than a major inflation threat, unlike in 2021-2022. Higher rates have already transmitted into financial conditions and housing; much of the growth drag likely occurred in 2022. The first rate cuts are forecast for Q2 2024, but cuts are viewed as optional rather than necessary. Recession risk has declined because the main threat—Fed over-tightening into an inflation fight—has become much smaller.

Data Points: Recession probability (12 months): 15% - Goldman Sachs cut its forecast to the historical unconditional average. Expected September Fed hike: Unlikely - Jackson Hole language suggests the Fed will probably pause. Expected last hike in cycle: July 2023 hike - Mericle says the July hike will likely prove to be the final increase. Wage growth tracker: Mid-4% range - Still about 1 percentage point too high relative to inflation goals. Core inflation target-adjacent level: ~2.5% - Seen as close enough to 2% and not expected until late 2024. Timing of core PCE below 3%: Q2 2024 - Threshold used for the first projected cut. Policy rate at current time: 5.25%–5.5% - Current Fed funds rate discussed as high relative to neutral. Real funds rate: 3%+ - Used to argue policy is already restrictive. Projected cut pace: 25 bps per quarter - Forecasted rate-cut path mirrors the prior hiking cycle’s gradualism. Projected end point for cuts: Low threes - Goldman’s forecast is above the Fed’s 2.5% longer-run dot. Longer-run Fed dot plot: 2.5% - Mericle is skeptical the Fed will ultimately normalize all the way there.

Pivotal Quotes: "“I think the July hike will turn out to be the last hike of the cycle.”" — David Mericle: Summarizing Goldman Sachs Research’s view on the end of Fed tightening. "“We cut our recession probability for the next 12 months just a couple of days ago down to 15%.”" — Alison Nathan: Opening framing for the discussion on U.S. economic resilience and recession risk. "“The purpose of hiking interest rates further would be to tighten financial conditions by more… to the extent that the market… is pushing up the medium to longer term interest rates… that reduces the need for the Fed to tighten.”" — David Mericle: Explaining why rising market rates lessen pressure on the Fed to deliver additional hikes.

Implications: For consumers and investors, the message is softer policy tightening, a higher chance of a soft landing, and eventual but cautious cuts in 2024. Rate-sensitive areas may still feel strain, but recession risk looks lower than earlier in the cycle.