On Wall Street, investment bank forecasts are nothing new, but Goldman Sachs's views are always worth paying special attention to. Why?
First, because the bank’s economists have been firmly in the soft landing camp, and now look prescient. Second, Goldman chief economist Jan Hatzius went against the consensus in 2008 when he made an equally unexpected yet prescient call, correctly warning that mortgage defaults could lead to a severe recession.
One successful prediction might be luck, but two might attract followers. Hatzius is one of the most watched economists on Wall Street and in Washington.
“Everyone on the White House economics team reads Goldman Sachs more obsessively than any other investment bank,” said Jason Furman, who served as President Obama’s economic adviser from 2009 to 2017. Recently at X, Biden’s economic adviser Jared Bernstein praised Hatzius as “outstanding.” Federal Reserve Chairman Powell has met with him several times, according to Powell’s publicly released schedule.
Hatzius’s forecasts are fairly accurate, which obviously helps his popularity. He is one of the few economists to have won the Lawrence R. Klein Award for Blue Chip Forecasting Accuracy twice (in 2009 and 2011). While like most economists he underestimated inflation in 2021 and 2022, his 2023 inflation forecast ranked fifth out of 68 economists evaluated by the Wall Street Journal.
What really attracts followers, however, is the depth and volume of his team’s research. Hatzius’ team, which consists of 12 Goldman Sachs U.S. economists (including chief economist David Mericle) and 29 global economists, regularly publishes detailed quantitative answers to popular questions, such as the extent to which artificial intelligence will promote long-term growth, the benefits of replacing lockdowns with mask-wearing, or what large-scale union wage settlements mean for inflation.
The team compiles its own set of economic indicators, including a widely imitated financial conditions index developed in 2000 by Hatzius and his then-boss Bill Dudley, which measures the overall effect of monetary policy by combining interest rates, bond yields, stock prices and the dollar.
Breaking the market consensus again and again
Hatzius, 55, who was born and raised in Germany, said in an interview that he was initially interested in history and politics but that he was “a little frustrated with everything in those fields.” “It was a lot of opinion and not much of an analytical framework,” he said.
So he went to study economics at the University of Freiburg, then earned a doctorate at Oxford University. He gave up on becoming a professor because he thought his interests were too broad for academia. He joined Goldman Sachs in 1997, succeeding Dudley (who later became president of the New York Fed) as the bank's chief U.S. economist in 2005, became a partner in 2008, chief economist in 2011, and head of research in 2020.
Hatzius’s eclecticism is essential to his approach. He believes that no single framework works for every economic or interest rate cycle.
In 2007, many analysts dismissed the significance of subprime mortgage losses by simply comparing them to a bad day for the stock market. In a report that November, Hatzius called the analogy flawed. He cited research by economists Tobias Adrian and Hyun Song Shin, noting that stocks were mostly held by “long-only” investors, such as pension funds, who “passively accepted losses in net worth.”
Mortgages, by contrast, are held by leveraged institutions such as banks, investment dealers, hedge funds, Fannie Mae and Freddie Mac. For every dollar these investors lose, they must shrink their balance sheets to maintain capital ratios. This is a key reason why Haszus predicts slower economic growth and a higher-than-consensus risk of recession in 2008.
After the recession hit, Hatzius again defied consensus by correctly predicting that bond yields would fall despite huge federal deficits. Drawing in part on the work of British economist Wayne Godley on the flow of credit, Hatzius argued that public borrowing would not push up inflation or interest rates when private borrowing was so weak.
Hatzius also made mistakes, especially when it came to the Fed’s interest rate moves: He didn’t anticipate the surge in inflation after the pandemic ended, nor did he realize in time how much the Fed would raise rates in response.
“You can be right about the big picture and still be wrong about the tactical aspects, especially when it comes to human or central banker behavior,” Hatzius said.
The gap between Hatzius’ economic forecast (yellow) and the market consensus (green)
What will happen in the future?
Goldman Sachs is optimistic about the economy this year. Its economists expect the economy to grow 2.3%, the unemployment rate to remain below 4%, and the chance of a recession to be just 15% - all of which are more optimistic than the market generally expects. They expect core inflation, which excludes food and energy, to continue to decline, with the Federal Reserve's preferred indicator falling to just above 2% by the end of the year.
As for the big picture, Hatzius still emphasizes that inflation can return to 2% without rising unemployment. In late 2022, his team provocatively borrowed Wall Street’s most dangerous word to name its 2023 outlook: “This cycle is different.”
The bank believes that the overheated labor market will cool down through a reduction in job vacancies rather than a rise in unemployment, while improvements on the supply side will reduce inflation. Ultimately, the rebound on the supply side even exceeded Goldman Sachs' expectations, and US economic growth in 2023 exceeded its optimistic expectations.
For 2024, Goldman Sachs expects more of the same.
Many economists believe that the lagged effects of rate hikes could still trigger a recession. But Hatzius believes the so-called lag effect is misunderstood. He said that the lag of interest rates on output levels is long, but the lag on GDP growth is short and has passed. Therefore, as supply recovers further, inflation may continue to fall as the economy grows solidly.
The latest data did not match Goldman Sachs' forecasts. Retail sales were weak in January and inflation remained high. Goldman Sachs blamed the inflation on corporate price increases at the beginning of the year, believing that it reflects past rather than future trends.
The data show housing costs are also rising fast. But in a 13-page report released Sunday, Goldman Sachs called January’s rise an anomaly that delved into private rent data and the Labor Department’s calculation methodology.
Many still question the prospects of a soft landing. Dudley expects unemployment to rise sharply and the economy to fall into recession. However, the former Hatzius boss admitted that "things are definitely going in the direction of Hatzius."
The article is forwarded from: Jinshi Data
