US Midyear Outlook: Geopolitical Shocks, the New Fed Era, and Growth

Episode Summary

Executive Summary: Goldman Sachs chief U.S. economist David Mericle said the economy has been more mixed than expected: labor-market resilience and business investment are supporting growth, but inflation is likely to stay nearer 3% than 2% because tariff, war, and AI-related price effects remain. He expects softer inflation readings ahead, the Fed to stay on hold this year, and the main upside risk to be renewed war-driven energy shocks.

Main Topics: Inflation outlook: softer near term, but not back to 2% yet (Priority: 5/5): Mericle said the recent weak June CPI was likely an outlier, but also the beginning of a period of softer monthly inflation as tariff effects fade, war-related price spikes peak, and AI-related mismeasurement in PCE eases sequentially. Fed policy under new chairman Kevin Worsch (Priority: 5/5): He expects the July FOMC to hold rates steady and sees the Fed remaining on hold through year-end, with little appetite to keep 'litigating' the causes of inflation if elevated readings persist. Labor-market resilience and growth surprise (Priority: 4/5): Job growth rebounded unexpectedly after a weak stretch, removing labor-market weakness as a near-term concern and suggesting growth is holding up better than feared despite higher oil prices. Market mispricing of Fed hikes (Priority: 4/5): Market pricing still leans toward hikes, but Mericle считает that view too aggressive; he sees hikes as less likely than markets imply, though not impossible. Fed balance-sheet strategy and Treasury coordination (Priority: 3/5): He sees little room to shrink the balance sheet materially, but considers the composition debate—bills versus duration—more open and ultimately not hugely consequential because Treasury can adapt. Fed communication and transparency (Priority: 3/5): Mericle discussed possible changes to Fed communication, including reducing emphasis on SEP medians, while warning that eliminating projections entirely would reduce transparency and could raise market volatility. Growth outlook: near potential, but cooling (Priority: 4/5): He expects U.S. GDP growth around 2%, as stronger business investment is offset by softer consumption, housing weakness, and lower government spending.

Key Arguments: Recent inflation softness is real but likely overstated by the June CPI; a run of softer prints is still expected. Tariff-related inflation effects are now negligible on a forward monthly basis. War-related oil effects likely peaked in Q2; if oil holds near current levels, inflation should continue easing sequentially. AI demand and related mismeasurement have inflated PCE, but those effects should soften in coming months. The Fed is done 'litigating' the causes of inflation and will focus on the level of inflation itself. Core PCE around 0.2% monthly would be enough for the Fed to stay on hold, but there is little margin for error. The labor market has unexpectedly strengthened and is now above the estimated break-even job creation rate. U.S. growth is slowing only modestly and should remain close to potential, supported by business investment and a wealth effect from equities. Market expectations for further hikes appear somewhat too aggressive relative to Goldman Sachs Research's forecast. The biggest macro risk remains the war, because it could reaccelerate inflation and force a tighter policy response.

Data Points: June CPI: weaker than expected - Used as evidence of softer inflation, though Mericle called it likely an outlier Job growth trend: picked up over the last four months - Unexpected labor-market resilience after nearly a year of weak hiring Break-even monthly job growth: 50,000 to 60,000 jobs - Estimated jobs needed to keep unemployment stable in a low-immigration environment U.S. growth forecast: around 2% - Goldman Sachs Research expectation for GDP growth in the back half of the year Potential growth estimate: 2.5% - Level growth was running above earlier in the year Stock-market wealth effect: 3 to 4 tenths of a percentage point - Estimated boost to consumer spending over the last year and the next year Core PCE inflation path: about 20 basis points monthly or a touch higher - Goldman's expected pace, viewed as soft enough for the Fed to hold Inflation comparison: closer to 3% than 2% - Mericle's view of where inflation is likely to settle given ongoing distortions Probability of hikes: about 25% - Goldman Sachs Research's estimate for eventual hikes, versus a higher market-implied probability Market-implied odds: roughly a 50-50 chance of two or three hikes - Mericle's characterization of pricing of a 'hike and a half'

Pivotal Quotes: "we think inflation will go more sideways, stay closer to 3% than to 2%" — David Mericle: Describing the revised inflation outlook after tariff, war, and AI-related effects "the Fed on hold at the July meeting" — David Mericle: His base-case view following the softer June CPI print "the biggest risk, at least for what we focus on, is probably still the war" — David Mericle: Summarizing the main upside risk to inflation, policy, and markets

Implications: Listeners should expect a Fed pause in the near term, modestly slower but still solid U.S. growth, and inflation that improves only gradually. The main risk is an energy-driven inflation flare-up that could delay cuts or revive hikes.