Rising Above Recession: Goldman Sachs Anticipates July Rate Hike, Risk Assets Poised To Scale Wall Of Worry

Goldman Sachs GS has revised its estimate about the U.S. economy's chance of entering a recession over the next 12 months.

The investment bank has reduced its judging probability from 35% to 25%, stating two major reasons for this change.
Jan Hatzius, Goldman Sachs' chief economic strategist, highlighted that the potentially disruptive debt ceiling dispute has vanished as a result of a recent bipartisan budget agreement. This deal has resulted in relatively moderate spending cuts, which will keep the overall fiscal impulse broadly neutral over the next few years.

The second reason for the optimistic view of Goldman Sachs analysts on the U.S. economy is that they are more certain about the impact of banking stress on real GDP growth. Hatzius cited a number of encouraging signs, including the stabilization of regional bank stock prices, slower deposit withdrawals, stable lending volumes, and lending surveys indicating modest tightening in the near future.

Goldman Sachs Expects 0.25% Hike in July, Followed By Steady-High Interest Rates

According to Goldman Sachs, the Federal Reserve will continue to demonstrate its willingness to impose future interest rate hikes. As a result, the firm has factored in a further 25-basis-point rise, which is expected to take effect in July. With this adjustment, the peak funds rate would be in the 5.25-5.5% range. After the rate increase, there is likely to be a long pause of about a year, followed by gradual rate cuts.

Hatzius noted that, in his opinion, the rates market is underestimating the outlook for the funds rate over the next 1-2 years, underlining the possibility of market mispricing.

According to the CME Group Fed Watch tool, traders presently assign a 22% probability of a Fed rate hike in June and a 65% probability of a hike in July. In addition, the Fed funds rate is expected to decline to 4.75% by the end of the year. 

Risky Assets To Continue Climbing "The Wall of Worry"

"Risk asset may continue climbing the wall of worry," Hatzius wrote in the note, as markets hold excessive bearish views about the sustainability of the rally. However, "the high level of valuations" may limit the upside from here, particularly if rates continue to increase.

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