(Brendan McDermid/Reuters)
Last week was the kind that investors dream about.
Markets vaulted higher after the Federal Reserve policy meeting concluded on Wednesday — the S&P 500 and Dow Jones Industrial Average closed with two back-to-back record highs and the tech-heavy Nasdaq Composite notched three consecutive highs before breaking for the weekend.
The S&P 500 knocked past the key threshold level of 5,200 and the Dow had its best week of the year.
A lot of people made a lot of money.
So where do we go from here?
Before the Bell spoke with David Mericle, Goldman Sachs' chief US economist, to discuss what exactly investors were celebrating, whether it can continue and why he thinks the chance of a recession are just about as low as they can be.
This interview has been edited for length and clarity.
Before the Bell: It's an understatement to say that Wall Street was happy with the results of last week's Federal Reserve policy meeting. Markets have rallied to new highs, and a global rally is underway. But the meeting left things exactly where they were. Is it possible that investors are celebrating a bit too hard, and could this rally soon lose momentum?
David Mericle: I do think we learned something this week: The next few inflation prints don't need to be amazing for [the Fed] to follow through on cutting rates in June. They stuck to that three-cut median in the dot plot despite raising their inflation forecast by two-tenths of a percentage point for this year. So our basic assumption is that [inflation data from] January and February will prove to be outliers and that, going forward, we will see inflation step back down to something like the pace that we were running at in the back half of last year.
The message from the FOMC [Federal Open Market Committee] is that even if [inflation rates aren't] as low as what we're forecasting, there's still a little bit of wiggle room to nevertheless deliver that June cut. The leadership seems to feel pretty strongly about not waiting indefinitely to get started. So markets didn't really know exactly what we needed to see on inflation prior to this week, and now we found out that we need to see a little bit less. That's positive information for markets.
Markets still seem somewhat uncertain about whether the first rate hike will be in June or July...
We still have three rounds of inflation reports ahead of us before June. It's still three months off. Markets probably shouldn't be pricing in anything with too much certainty at that horizon. But the meeting did have some impact on market pricing. [About 70% of investors now think a rate cut will occur in June, according to the CME FedWatch tool.]
Goldman Sachs is currently predicting a 15% chance of recession over the next 12 months, down from 35% last year. What's the significance of that change?
That was a meaningful change from 35% down to 15%. And the reason that we made that change was we felt we had sufficient evidence that two things that we worried about in real time had worked out.
One was that the hard part of the inflation fight was over. Inflation expectations were back to normal, and the labor market had largely rebalanced to its pre-pandemic state without the unemployment rate going up. Seeing that happen made us more confident that the Fed wouldn't be forced to cause a recession in order to get inflation down.
The other thing was that we learned enough about the regional banking stress of last spring to not worry as much anymore.
Once those two risks had passed, it's not that there was no probability of recession. There's always some — in late 2019 we thought the probability of recession was very low. It's a good reminder that unexpected things like the pandemic can always surprise us. So we always want to make some allowance for that. The reason we say 15% risk is because that is roughly the historical unconditional average. So if you were just in a typical year and there was nothing particularly distinctive to worry about, we would say the recession risk was 15% over the next 12 months. But the reasons that we saw the recession probability as higher than usual I feel today are behind us.
So a 15% recession rate is baseline for you, it will never go below that number?
By looking back at recent history, we can think of it as how often when we weren't in recession have we gone into recession over the next 12 months.
Are we thinking about recession in the wrong way? Some economists say we've been in a rolling recession over the last few years.
I'm going to refrain from saying anything about those theories because I don't have anything nice to say about them. Look, I think the way we define recession, through the National Bureau of Economic Research's Business Cycle Dating Committee, is a holistic approach that looks at many different sources of data. The way that we do this, looking at a variety of data, is a sensible way of doing it.
Are we in an unprecedented economic environment right now?
There have been a lot of unprecedented things that have occurred over the last few years, but at this point, I think we are moving back into more familiar territory. We're not there yet, obviously. But broadly we are gliding back to that pre-pandemic dynamic where we had a very strong labor market by historical standards but did not have an inflation problem. The key thing that's different is that interest rates are likely to wind up meaningfully higher than they were last cycle. But if your historical memory stretches beyond last cycle, then where interest rates are likely to settle this time around doesn't look unprecedented. Broadly, we seem to be heading back to somewhere pretty familiar — basically, where we left off.
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