The Markets: Pricing in the probability of a recession

Episode Summary

Executive Summary: The episode centers on a cooler-than-expected inflation print, easing but still meaningful credit tightening after banking stress, and the market/Fed implications. Joseph Briggs argues the data support a June Fed pause, that credit drag should slow growth without causing recession, and that consumer spending remains resilient thanks to solid real income growth and balance sheets. Debt-ceiling uncertainty adds to the case for caution.

Main Topics: Inflation is cooling, led by shelter and softer core services (Priority: 5/5): Briggs interprets the latest CPI as broadly positive despite sticky core inflation, noting used cars distorted the headline and that shelter inflation and core services ex-rent are slowing in line with Goldman’s expectations. Bank lending standards are tightening after banking stress (Priority: 5/5): The Fed’s Senior Loan Officer Survey showed tighter lending standards and weaker loan demand, but Briggs says the pullback was less severe than feared and likely a manageable drag on GDP rather than a recession trigger. Fed policy outlook: pause likely, rate cuts unlikely soon (Priority: 5/5): The combination of slower inflation, tighter credit, and elevated uncertainty makes a June pause highly likely, while current market expectations for imminent cuts are viewed as overly aggressive. Sector exposure to bank credit is uneven (Priority: 4/5): Manufacturing, commercial real estate, and some service sectors such as leisure and hospitality are more exposed to bank lending, so they may face larger activity and hiring headwinds. Consumers remain resilient on income and balance sheets (Priority: 4/5): Strong real income growth and healthy balance sheets are supporting consumer spending and helping explain better-than-expected earnings results across many companies. Debt-ceiling uncertainty is a market overhang (Priority: 3/5): Briggs says negotiations are opaque and uncertainty is elevated, reinforcing caution in markets and possibly reducing the Fed’s urgency to hike. Near-term data watch: retail sales (Priority: 3/5): With a lighter data calendar ahead, retail sales are the key upcoming indicator to assess whether consumer spending is rebounding after recent underperformance.

Key Arguments: Core CPI was still firm, but much of the upside came from used cars and should reverse as summer progresses. Shelter inflation continued to cool, and new lease data suggest further moderation ahead. Core services excluding rent and OER slowed sharply, signaling broader underlying disinflation. Bank lending standards tightened as expected after banking turmoil, but the deterioration was less severe than feared. Goldman estimates the credit crunch will subtract about 0.4 percentage points from 2023 GDP, a headwind but not recessionary. The Fed is likely comfortable pausing in June because inflation is easing and the June payrolls report would need to be very strong to change that. Market pricing for rate cuts appears overdone because the growth hit from tighter credit is not expected to be large enough to force easing. Manufacturing, commercial real estate, and bank-dependent services will likely feel the biggest credit squeeze. Consumer spending should hold up because real income growth is projected at 3.5% to 4% and household balance sheets remain strong. Debt-ceiling uncertainty increases caution in markets and may be another reason for the Fed to avoid hiking soon.

Data Points: Core inflation: 41 basis points - April CPI core inflation; Briggs said it was still too firm but broadly positive. Core services excluding rent and OER: 11 basis points - Chair Powell’s preferred measure slowed in April, indicating softer underlying inflation. Real consumer income growth: 3.5% to 4% - Goldman’s view for consumer income growth this year, supporting spending resilience. Estimated GDP drag from credit crunch: 0.4 percentage point - Goldman’s estimate of the 2023 growth hit from tighter bank credit. Fed policy move: 25 basis points - The Fed had raised rates by a quarter percentage point one week before the interview. Upcoming data watch: May payrolls report - Identified as the last major data release before the June FOMC meeting.

Pivotal Quotes: "Overall, the CPI print was pretty positive." — Joseph Briggs: Opening assessment of the latest inflation report. "Our analysis suggests that the size of the hit is probably more likely to be a headwind, but not enough to push us into a recession and prompt the Fed to actually cut rates." — Joseph Briggs: Explaining the expected economic impact of tighter credit and why markets may be too aggressive on rate-cut pricing. "At this point, I think that it would take a series of very significant upside surprises to prompt the Fed to hike at June." — Joseph Briggs: Fed outlook ahead of the next meeting.

Implications: Markets may keep rallying on lower inflation, but Goldman expects a June Fed pause rather than cuts. Credit tightening is a real drag, especially for credit-dependent sectors, yet consumer resilience lowers recession risk.