Here are the 3 things the Fed needs to do to stick a soft landing and avoid a recession, according to Goldman Sachs

  • The Fed’s goal of sticking a soft landing is within reach, according to a note from Goldman Sachs.
  • The Fed is tasked with cooling down the economy to help supress inflation without creating a recession.
  • These are the three things the Fed needs to do to tame inflation without sparking a recession, according to Goldman. 

The Federal Reserve still has a narrow path to sticking a soft landing in the economy as it raises interest rates to tame inflation, according to a Sunday note from Goldman Sachs.

A soft economic landing would be the best-case scenario for stock market investors, as it would alleviate concerns of an imminent recession, which have sent the S&P 500 tumbling into bear market territory earlier this year, falling as much as 24% from its January peak.

“Our broad conclusion is that there is a feasible but difficult path to a soft landing, though several factors beyond the Fed’s control can ease or complicate that path and raise or lower the odds of success,” Goldman’s Jan Hatzius said.

Here’s what Fed chairman Jerome Powell needs to do to guide the economy towards a soft landing and avoid a recession, according to Goldman.

1. “Slowing GDP growth to a below-potential pace.”

“The combination of the steady decline in fiscal support and the large tightening in financial conditions engineered by the Fed has achieved a much-needed deceleration. We now forecast GDP growth of just over 1% over the next four quarters, though the recent easing in financial conditions could make it harder to stay on track,” Hatzius said.

2. “Rebalancing supply and demand in the labor market.”

“Rebalancing supply and demand in the labor market is off to a good start but has a long way to go. Labor supply has stagnated this year, and we no longer expect much of a recovery in the participation rate. Labor demand has moderated as job opening have fallen sharply, though hiring continues to run as several times the target pace. Taken together, this means that the jobs-workers gap has closes by about 25% of the amount that we estimate is necessary,” Hatzius said.

3. “Bringing down wage growth and inflation.” 

“Bringing down wage growth and inflation shows little convincing progress so far. Wage growth has moved sideways at 5.5%, 2 percentage points above the 3.5% pace that we estimate is compatible with 2% inflation. On inflation, the good news is that falling commodity prices and supply chain recovery are delivering a long-awaited and much-needed disinflationary impulse from the goods sector. The bad news is that high inflation is broad-based, measures of the underlying trend are elevated, and business inflation expectations and pricing intentions remain high,” Hatzius said.

Two doubts the Fed faces is whether labor demand can fall without a large increase in the unemployment rate, and whether or not high inflation becomes normalized as labor sees a rebalance in supply and demand, according to Goldman.

Going forward, Goldman expects the Fed to raise interest rates by 50 basis points in September and 25 basis points in November and December, representing a soft pivot from the Fed’s back-to-back 75 basis point rate hikes in June and July.