The risks of a recession are growing, according to Goldman Sachs economists.
In a Monday analyst note, Goldman strategists led by Jan Hatzius said the probability of an economic downturn within the next 24 months is 38%. While that forecast is lower than some of their Wall Street peers, the analysts admitted risks to the outlook have grown over the past month.
"Recession risk has risen," Hatzius wrote. "The financial health of the private sector may ultimately determine whether policy tightening will tilt the economy into a downturn."
But there is a bright spot in the economy, according to the Goldman analysts: Strong consumer demand, which could help the Federal Reserve to engineer a so-called soft landing — the elusive sweet spot between curbing demand enough to cool inflation without actually triggering a recession.
Strong spending among consumers stems from pent-up demand as well as trillions in government stimulus money at the height of the COVID-19 pandemic. U.S. households, according to Goldman Sachs, had a financial surplus of 4% of GDP in the final three months of 2021, compared to a 2.8% average from 1985 to 2019.
"Surpluses generated today by households and high-yield businesses bolster the outlook for consumer spending and business investment—and will help offset the [Fed] policy and inflation headwinds," the analysts wrote. "The healthy private sector financial balance widens the Fed’s narrow runway for a soft landing."
There are growing fears on Wall Street that the Federal Reserve could inadvertently trigger a recession as it takes a more aggressive approach to fighting inflation, which is at the highest level since December 1981. Policymakers raised rates by a quarter-percentage point in March, and have since confirmed that sharper, half-point increases are likely in the coming months, beginning during its two-day meeting this week.
"It is appropriate to be moving a little more quickly," Fed Chairman Jerome Powell said last week during a panel discussion at the International Monetary Fund and World Bank spring meetings. "I also think there’s something in the idea of front end-loading whatever accommodation one thinks is appropriate. So that points in the direction of 50-basis points being on the table."
Traders are now pricing in a 100% chance of at least a half-point rate jump at the conclusion of policymakers' meeting on Wednesday. It would mark the first time since 2000 that the U.S. central bank raised the federal funds rate by 50 basis points.
Some economists believe the Fed waited too long to confront the burst in inflation, while others have expressed concerns that moving too quickly to stabilize prices risks triggering an economic recession. Hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.
Powell has pushed back against concerns that further tightening by the central bank will trigger a recession and has maintained optimism that the Fed can strike a delicate balance between taming inflation without crushing the economy.
Still, he acknowledged the difficulty of the task ahead and said it is "absolutely essential" for central bankers to restore price stability.
"Our goal is to use our tools to get demand and supply back in sync, so inflation moves back into place, without a slowdown that amounts to a recession," Powell said. "I don't think you'll hear anyone at the Fed say that's straightforward and easy. It's going to be challenging."
The analyst note comes just a few days after the Commerce Department reported that gross domestic product, the broadest measure of goods and services produced across the economy, shrank by 1.4% on an annualized basis in the three-month period from January through March.
It marked the worst performance since the spring of 2020, when the U.S. economy was still deep in the throes of the COVID-induced recession.