What’s ahead for economies and markets in 2023?

Episode Summary

Executive Summary: Goldman Sachs economists Jan Hatzius and Dominic Wilson argue the U.S. can avoid recession in 2023 as inflation cools, income growth improves, and the drag from tighter financial conditions peaks. They expect the Fed to slow hikes, Europe and China to outperform earlier fears, the dollar to weaken, and bonds to become more attractive, though recession and market downside risks remain meaningful.

Main Topics: U.S. soft landing versus recession risk (Priority: 5/5): Hatzius argues the U.S. baseline is no recession, supported by improving real disposable income and a peaking drag from monetary tightening, though recession risk remains material. Inflation disinflation drivers (Priority: 5/5): The discussion emphasizes that inflation can fall without a deep downturn because expectations are anchored and several 'inflation freebies'—commodity declines, supply-chain normalization, and easing rents—are already in motion. Fed policy path and rates outlook (Priority: 5/5): Goldman expects the Fed to slow to 25 bp hikes and then pause around 5%-5.25%, with cuts only if recession emerges; this is close to the Fed's own projections but slightly more hawkish on the probability-weighted path. Market pricing across assets (Priority: 4/5): Wilson explains markets are still pricing recession talk and some cuts, but not fully pricing a recession; equities, bonds, and inflation markets reflect a more optimistic scenario than the dominant narrative suggests. Europe and China growth reacceleration (Priority: 4/5): Europe's outlook improves as gas prices fall and energy stress eases, while China is expected to rebound sharply after reopening, providing a positive global growth impulse. Dollar peak and non-U.S. asset implications (Priority: 4/5): With Fed tightening maturing and growth improving abroad, Goldman thinks the dollar likely peaked in late 2022 and that non-U.S. equities may continue outperforming in the near term. Risks and asymmetric market outcomes (Priority: 5/5): The speakers stress the narrow path to soft landing: too little weakness risks sticky inflation, while too much could trigger recession; recession would hurt equities/credit but likely help bonds via deeper, earlier cuts.

Key Arguments: U.S. real disposable income is recovering because fiscal drag has faded and headline inflation is slowing faster than wages, supporting consumer spending. The tightening impact from monetary policy and financial conditions is already near its peak and should diminish through 2023. Unlike the 1970s, inflation expectations are well anchored near 3%, making a soft landing more plausible. Disinflation can come from commodity normalization, supply-chain repair, and lower rents without requiring a severe recession. The labor market is overheated mainly through excess job openings, not excessive employment, so rebalancing can occur via fewer vacancies rather than a large rise in unemployment. The market is less recessionary than headlines suggest, but still pricing some rate cuts; if growth holds up, those cuts may need to be removed. Bond returns look more attractive than in 2022 because yields are higher, volatility has peaked, and bonds now offer better recession protection. European recession risk has eased due to better hard data and lower gas prices, while China's reopening should support global growth and German exports. The dollar likely peaked in late 2022 because the Fed is moving toward the end of tightening and non-U.S. growth is improving. A recession would still cause meaningful downside to equities and credit, especially if inflation progress reversed, though the probability of that has fallen recently.

Data Points: U.S. recession probability: 35% - Goldman’s estimated probability of recession in 2023, despite a no-recession baseline. Real disposable income growth: 3% to 3.5% - Expected U.S. growth in real disposable household income as inflation eases and fiscal drag disappears. Financial conditions drag on growth: ~2 percentage points - Estimated subtraction from U.S. growth from tighter financial conditions around late 2022/early 2023. Inflation expectations: ~3% - Five- to ten-year University of Michigan inflation expectations, cited as well anchored and historically consistent with ~2% inflation. U.S. job openings: Above 10 million - Evidence of labor market overheating through excess vacancies. U.S. unemployed workers: About 6 million - Used to highlight the vacancy-to-unemployed mismatch in the labor market. Jobs-workers gap: More than 4 million - The size of the labor market imbalance that needs to be corrected. U.S. real GDP tracking estimate for Q4: 2.6% - Current tracker cited as evidence that hard data remain firm even while surveys weaken. Payroll growth: More than 200,000 - Recent U.S. payroll gains cited as robust labor market evidence. Jobless claims: Close to 200,000 - Low claims data cited to show continued labor market strength. Six-month T-bill yield: 4.65% - Illustrates the attractiveness of cash as an alternative asset in the current rate environment. ECB deposit rate baseline: 3.25% - Projected ECB policy rate after additional hikes. ECB current deposit rate: 2% - Reference point for the expected path of ECB tightening. China 2023 GDP forecast: 5.2% - Goldman’s annual average growth forecast after reopening. China 4Q/4Q GDP forecast: 7.2% - Expected late-2023 rebound pace from reopening effects. China GDP gap versus pre-COVID baseline: 4% to 5% below - Estimated output gap before reopening, indicating room for above-trend recovery.

Pivotal Quotes: "We do assign a 35% probability to a recession. That's not a low number, but we feel good about the idea that the baseline is no recession." — Jan Hatzius: Summarizing Goldman’s central 2023 U.S. macro outlook "We feel pretty good about the idea that a soft landing is possible. It doesn't mean it's assured." — Jan Hatzius: On why disinflation and labor-market rebalancing may occur without a recession "If we move along this track where the economy holds up, you don't get the recession, inflation's cooling gradually, those cuts are going to have to come out." — Dominic Wilson: On market pricing of Fed cuts versus Goldman’s baseline forecast

Implications: Listeners should expect a 2023 backdrop of slower but positive growth, easing inflation, and fewer rate shocks. The key investment themes are better bonds, more selective equities, a softer dollar, and improved non-U.S. opportunities—while still watching recession risk closely.