The recession question

Episode Summary

Executive Summary: Goldman Sachs’ Jan Hatzius and Dominic Wilson argue that the sudden rise in U.S. tariff rates has shifted the outlook from “tailwinds trump tariffs” to a materially weaker growth, higher inflation, and higher-volatility regime. They see recession risk near 50/50, expect the Fed to face a difficult tradeoff, and warn that Treasuries and the dollar may no longer serve as reliable safe havens.

Main Topics: Tariff shock and U.S. growth outlook (Priority: 5/5): Hatzius explains that tariff increases are now large enough to outweigh prior economic tailwinds, with growth hit through higher prices, tighter financial conditions, and weaker capex from uncertainty. Inflation, recession risk, and Fed policy (Priority: 5/5): Goldman raises its inflation forecast while cutting growth, leaving the Fed in a bind between fighting tariff-driven inflation and responding to weaker activity and possible labor market deterioration. Treasury market stress and safe-haven breakdown (Priority: 5/5): Wilson discusses why long-dated Treasury yields rose during turmoil, citing foreign demand concerns, leverage unwinds, liquidity stress, and doubts about Treasuries as a dependable safe haven. Equity and credit market pricing (Priority: 4/5): The market has largely repriced toward a weak-but-nonrecessionary baseline, but Goldman thinks downside risks remain underpriced and that equities, credit, and risk assets still have room to fall if recession risk materializes. Uncertainty as a lasting economic drag (Priority: 4/5): Hatzius argues trade-policy uncertainty is difficult to quantify but likely reduces investment for a prolonged period and may not be fully reversible even if tariffs are eased. China exposure and global spillovers (Priority: 4/5): China is the main tariff target, but Goldman notes both the U.S. and China face damage; most major economies have had growth forecasts cut, showing the shock is broadly negative-sum. Dollar weakness and portfolio reallocation (Priority: 4/5): Wilson says the dollar is weakening because investors are reassessing U.S. assets, hedges, and institutional/policy risk, with more room for yen, Swiss franc, euro, and gold strength.

Key Arguments: Tariffs now appear large enough to overwhelm earlier U.S. growth tailwinds, shifting Goldman’s U.S. outlook from manageable slowdown to near-stagnation. Each 1 percentage point rise in the average U.S. tariff rate roughly adds 10 bps to inflation and subtracts 10 bps from growth, implying a 15-20 point tariff increase is materially damaging. The probability of U.S. recession is now around 45%, with baseline 2025 Q4/Q4 GDP growth only about 0.5%. Core PCE inflation is expected to rise to 3.5%, with tariffs likely adding about a full percentage point from recent levels. The Fed faces conflicting signals: inflation will rise, but the key question is whether inflation expectations stay anchored and whether unemployment begins to rise. Goldman’s baseline still assumes 75 bps of cuts in June, July, and September, but the range of outcomes is wide and a recession could require much more easing. Long-dated Treasury yields rose because markets fear Fed constraint, fiscal deterioration, foreign buyer retreat, and unwinds of leveraged positioning. The Treasury selloff suggests that U.S. government bonds may be less reliable as a crisis hedge than in prior downturns. Equity and credit markets have not fully priced a recession; the market is closer to a weak baseline than to a true recession scenario. Trade-policy uncertainty is itself a growth shock, likely depressing corporate investment for an extended period even if headline tariffs later ease. China’s economy is under pressure despite additional stimulus, and Goldman still cut China growth forecasts to 4.0% for 2025 and 3.5% for 2026. The shock is global: most major economies tracked by Goldman saw forecast downgrades, reinforcing that this is a negative-sum environment. The dollar’s traditional tariff-era strength has broken down because investors now focus more on U.S. growth fragility, policy uncertainty, and portfolio concentration risk. Gold, yen, and Swiss franc have emerged as more dependable hedges than Treasuries or a long-dollar position.

Data Points: Average U.S. tariff rate impact on growth/inflation: ~10 basis points per 1 percentage point tariff increase - Goldman’s rough rule of thumb for the macro effect of higher tariffs Tariff increase considered manageable: 4-5 percentage points - Earlier scenario thought to be absorbable without recession Tariff increase considered recessionary: 20-25 percentage points - Peak stress scenario before the partial 3-month tariff delay Current tariff increase estimate: 15-20 percentage points - Post-delay estimate for the rise in average U.S. tariff rates U.S. recession probability: 45% - Goldman’s current estimate, described as close to 50/50 2025 U.S. GDP growth forecast: 0.5% Q4/Q4 - Goldman’s baseline for U.S. growth this year Core PCE inflation forecast: 3.5% - Goldman’s expected core inflation rate amid tariff pass-through Fed cuts in baseline forecast: 75 bps - Expected easing path, with cuts in June, July, and September Potential Fed cuts in recession scenario: up to 200 bps - Would be a more meaningful response if recession hits U.S. tariff increase on China: 145 percentage points - Latest total U.S. tariff increase cited by Wilson China retaliation against U.S.: 125 percentage points - Latest Chinese retaliatory tariff increase cited by Wilson China GDP forecast for 2025: 4.0% - Cut down from 4.5% due to trade war and offsetting stimulus China GDP forecast for 2026: 3.5% - Cut down from 4.0% in Goldman’s updated forecast China policy rate cut assumption: 60 bps total - Includes an additional 20 bp cut added to the forecast Major economies with growth forecast cuts: 21 or 22 out of about 25 - Goldman notes broad global downgrades over the last four weeks Tariff-related uncertainty growth drag: 0.5% to 1.0% - Hatzius’s rough assumption for growth lost to uncertainty effects Inflation/financial conditions/growth channels: 3 - Tariffs affect households, financial conditions, and corporate investment through three main channels

Pivotal Quotes: "we now think that tariffs will trump the tailwinds" — Jan Hatzius: Describing the shift in Goldman’s U.S. economic outlook after the tariff escalation "we are at 45% recession probability" — Jan Hatzius: Summarizing Goldman’s current baseline assessment of U.S. recession risk "it's going to be hard for investors to treat longer-dated treasuries as a comfortable safe haven" — Dominic Wilson: On the Treasury selloff and why long-dated U.S. bonds may no longer function as a reliable crisis hedge

Implications: Expect weaker growth, stickier inflation, and more market stress. Investors should favor diversification, non-U.S. safe havens, and close monitoring of U.S.-China trade, labor data, and Treasury market functioning.