Goldman Sachs is worried that inflation could rise faster than expected, and urged policymakers to take action to avoid “a dangerous overheating.” Their recommendation: five more 25 basis point hikes before assessing whether further hikes are necessary.
The U.S. economy showed no sign of slowing in October, as Friday’s jobs report showed payrolls growing by 250,000 and unemployment holding steady at 3.7%. But it was wage growth of 3.1% year-over-year that had economists wondering if the Fed now sees inflation near its 2% target. Goldman’s Jan Hatzius wrote Sunday that unemployment should continue to decline to 3% by early 2020, noting the labor market also has room to accommodate more wage growth. Hatzius predicted that average hourly earnings would likely grow in the 3.25% to 3.50% range over the next year.
That rapid pace of wage growth could set the Fed up for a “meaningful overshoot” of its 2% inflation target. “If unemployment is (perhaps well) below 3.50% and inflation above 2%, we think Fed officials will need to be quite confident that growth will stay at or below trend to sound an all-clear on further rate increases, which could translate into a large easing in financial conditions and a return to growth rates well above trend,” Hatzius wrote.
Hatzius wrote that the economy needs to slow to avoid overheating, and worries that inflation could run away if the Fed does not take action. For now, Goldman has a baseline forecast of 2.3% for core PCE — which it noted as within the Fed’s comfort zone — but warned that inflation is poised to move higher on President Donald Trump’s tariffs. The note also warned that with the labor market continuing to tighten, inflation will likely push “notably, not just slightly, higher.”
Hatzius said a slowdown could stabilize the unemployment rate, and already predicts that the economy will calm to a GDP growth rate of 2.6% in the fourth quarter. But if the slowdown is not enough, unemployment could destabilize into 2020 and inflation could run rampant. Goldman recommended five more rate hikes before reassessing if further hikes are necessary. That outlook is more hawkish than those of other Fed figures; Dallas Fed President Robert Kaplan said the Fed should take a step back after its next three hikes.
Hatzius said that the economic outlook is still subject to change from a number of geopolitical factors, such as the U.S. midterm elections on Tuesday and the trade conflict with China.
More News On Goldman Sachs
Goldman recovered more quickly from the financial crisis than many competitors — but a new scandal threatens to undermine its clean image Back in 2010, Goldman Sachs faced a near existential threat. Sued by the US Securities and Exchange Commission over allegations it had misled clients about mortgage-backed securities, Goldman appeared in internal emails to personify the arrogant self-interest that had helped cause the global financial crisis. Its executives were lambasted by the US Senate and its rivals scented blood.
But then chief executive Lloyd Blankfein acted quickly to lance the boil. The bank paid $550m to settle the allegations, he launched a top-to-bottom cultural review and spent 18 months visiting clients to reassure them that Goldman had got the message on ethics and was putting clients first.
It worked. Goldman recovered more quickly from the crisis than many of its competitors, grabbed new business and rushed into new markets. It leads the Financial Times league tables this year for fees in both equities and mergers and acquisitions, and is second overall only to JPMorgan.
But a new scandal threatens to undermine Goldman’s claims to be cleaner and more ethical, and raises questions about whether its leaders lost control of their empire amid their fervour for growth. Last week, the US Department of Justice revealed that two former senior Goldman bankers had been criminally charged with helping to loot 1MDB, a Malaysian state investment fund that authorities allege was victim of one of the biggest frauds of all time.
Goldman, which took home $600m for underwriting three 2012-13 1MDB bond offerings worth $6.5bn, an unusually high share of the proceeds, is under investigation. It has warned investors that its potential losses related to legal proceedings including 1MDB could run as high as $1.8bn above the money it had previously set aside for such matters. A spokesman declined to comment further.
In some ways, Goldman is in a much stronger position than it was in 2010. Anger against banks has eased, and the SEC is controlled by Republicans who have publicly raised doubts about the efficacy of big fines. Goldman’s role in the 1MDB scandal has been leaking out for several years and the share price ended higher last week.
But the allegations have the potential to cut much deeper this time around. In 2010, Goldman’s leadership was able to distance itself from the furore — the worst emails were written by a mid-level trader who was just 31 when the scandal broke. This time, a former partner, Tim Leissner, has pleaded guilty; a former managing director, Roger Ng, has been charged with money-laundering and bribery offences; and the bank has put Andrea Vella, a former co-head of Asian investment banking excluding Japan, on leave, after the DoJ alleged that a managing director, whose description fits him, knew of Mr Leissner’s activities. He has not been charged with wrongdoing.
Prosecutors also wrote that the bank’s “business culture . . . particularly in south-east Asia, was highly focused on consummating deals, at times prioritising this goal ahead of the proper operation of its compliance functions”.