Capitulation Redux Or August 2010 Deja Vu: Goldman Downgrades US Economy, Sees One In Three Risk Of Recession, Expects Some QE3 Announcement Next Week

Tyler Durden's picture

In a carbon copy of Goldman's action from exactly one year ago, Goldman's Jan Hatzius has just killed his outlook for the remainder of the year, said there is a 33% chance of a recession and is now looking forward to some QE3 announcement next week. "As foreshadowed in recent publications, we have lowered our US real GDP growth forecast to 2% (annualized) through 2012Q1 and 2½% thereafter.  We now see the unemployment rate edging up to 9¼% by the end of 2012, and see a one-in-three risk of renewed recession.  On the monetary policy side, we expect no rate hikes or changes in the size of the Fed's balance sheet until 2013 or later; moreover, we now expect the FOMC to provide more guidance about the future size of its balance sheet at next week’s meeting." Recall that 3 weeks after last year's such downgrade, we had a rather unpleasant announcement at Jackson Hole. Deja vu.... all over again.

From Goldman Sachs

BOTTOM LINE: As foreshadowed in recent publications, we have lowered our US real GDP growth forecast to 2% (annualized) through 2012Q1 and 2½% thereafter.  We now see the unemployment rate edging up to 9¼% by the end of 2012, and see a one-in-three risk of renewed recession.  On the monetary policy side, we expect no rate hikes or changes in the size of the Fed's balance sheet until 2013 or later; moreover, we now expect the FOMC to provide more guidance about the future size of its balance sheet at next week’s meeting.
 
MAIN POINTS:
1. We have lowered our forecast for US real GDP growth further and now expect real GDP to grow just 2%-2½% through the end of 2012.  Our forecast for annual average GDP growth has fallen to 1.7% in 2011 (from 1.8%) and to 2.1% in 2012 (from 3.0%).  Since this pace is slightly below the US economy’s potential, we now expect the unemployment rate to be at 9¼% by the end of 2012, slightly above the current level.
 
2. Even our new forecast is subject to meaningful downside risk.  We now see a one-in-three risk of renewed recession, mostly concentrated in the next 6-9 months.  There are three specific issues that concern us.  First, a worsening of the European financial crisis, and a failure of European policymakers to respond adequately, could lead to a further tightening of financial conditions and credit availability, which would worsen the economic outlook globally.  Second, our forecast assumes that the payroll tax cut—currently scheduled to expire at the end of 2011—is extended for another year, but if that failed to happen the fiscal drag in early 2012 would increase significantly.  Third, increases in the US unemployment rate have historically had a tendency to feed on themselves, and this could happen again.
 
3. Our inflation views have not changed much, but our conviction has increased that the large—and now growing—output gap will result in significant renewed disinflation.  Nominal wages are growing at a 2% rate, unit labor costs are roughly flat, and the temporary inflation impulse from higher commodity prices and the supply chain disruptions in the auto sector is waning.  We expect the year-on-year rate of core inflation to fall from a peak of around 2% in late 2011 to 1¼% in late 2012.
 
4. On the policy side, we now expect Fed officials to expand the scope of their “extended period” language to cover not just the exceptionally low funds rate but also the exceptionally large balance sheet.  Although the timing of this change is a fairly close call, our expectation is that the FOMC will make it at its August 9 meeting.  We also expect them to shift the maturity of their reinvestments in the Treasury market toward the longer end of the yield curve, although the August 9 meeting is probably still too early for such a shift.  Regardless of what happens next week, we expect the funds rate and the size of the Fed’s balance sheet to stay at their current levels of near-0% and $2¾-3 trillion until 2013.  Additional quantitative easing—i.e., a further sizable expansion of the balance sheet—sometime later in 2011 or in 2012 is possible, but is not our base case at this point.