Goldman Sachs Breaks From The Herd: What's Behind Out Consensus FOMC Interest Rate Call?

by Piero Cingari Benzinga Staff Writer

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Goldman Sachs expects a Fed pause in March, but three subsequent 25bp hikes to 5.25-5.5% in July.
Tighter lending standards by small and medium-sized banks may substitute for up to 50bp hike in interest rates
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Goldman Sachs GS expects the Fed to maintain rates unchanged and take a pause in its ongoing battle against inflation at this week's meeting. The central bank will hold off on an additional hike this month in light of the rising strain in the banking system, GS economic analyst David Mericle wrote in a note on Monday.

That’s an out-of-consensus call from Goldman Sachs, given that Fed funds futures are currently pricing in a 27% probability of the Fed pausing at 4.50%-4.75% and a 73% probability of a 25 basis-point increase.

According to the expert, tightening monetary policy in the face of continued stress in the banking sector poses a significant negative risk to the economy.

The fight against inflation seems to be less urgent now than it was a year ago, since near-term inflation expectations have fallen sharply while long-term inflation expectations have remained anchored.

Yet, once the present fog of uncertainty dissipates, the Fed will continue to communicate that it anticipates future rate rises would be required to lower inflation.

Target rate probabilities for March 22 FOMC meeting – Source: CME Group

Do Tighter Credit Standards Substitute for Fed Rate Hikes?

According to Goldman, small and midsize banks, particularly those most sensitive to pressure on their deposit bases, are likely to tighten lending rules in order to protect liquidity in case of depositor withdrawals.

The analyst estimated that a reasonable tightening in lending criteria would reduce GDP growth by a quarter to half a percentage point in 2023, which is similar to the effect of 25 to 50 basis points of Fed rate hikes.

What’s beyond March FOMC? Goldman has not altered its Fed outlook beyond March and continues to anticipate three further 25bp rate rises in May, June, and July, which would bring the funds rate to a maximum of 5.25-5.5%.

Instead, the market is pricing in the end of the interest rate rising cycle as early as this month, with the first three interest rate cuts expected by year-end (chart below).

Goldman Sachs expects that the new Fed Summary of Economic Projections this week will increase the median Fed funds estimate for 2023 by 25 basis points to 3.375%, and that market pricing of the Fed rate path has dropped further than they feel is reasonable.