Other forecasters may be overestimating the chances of an economic downturn if Goldman’s new model is any indication.
Talk about an impending recession have calmed down in the last few weeks, though many on Wall street are still concerned that the next one is just on the horizon.
Economic forecasters on average predict there’s a 35% chance of a recession in the next year, but Goldman Sachs has a new model to track recessions that says that might be a big overestimation.
The firm’s new model instead says that there’s a less than 25% chance we’ll see a U.S. recession in the next year.
“We see several reasons why standard models—and thus forecasters—may be overestimating recession risk at present,” wrote Goldman’s chief U.S. economist, Jan Hatzius, in a note to clients.
The new model includes adjustments for what Hatzius considers long term changes in the U.S. economy that other models and forecasters are missing, including low interest rates and unemployment.
“Even fewer models allow explicitly for structural changes in the economy that affect both the overall frequency of recession and its drivers,” he wrote.
In Goldman’s new model, the risk for an economy overheating is measured through core inflation rather than indirectly based on the unemployment rate. Historically, unemployment as low as it is now has triggered inflation, but that’s not happening this time around.
The firm is also focused on the short-end spread of the yield curve, which minimizes the influence of the longer portion of the curve. Other models, on the other hand, tend to rely heavily on data related to the yield curve and inflation, which have helped to predict recessions in the past.
With those changes in mind, Goldman’s model says there’s now just a 24% chance we’ll fall into a recession within the next twelve months.
“This is up significantly over the past year, mainly because of a flatter yield curve and weaker current growth,” Hatzius wrote in the note. “However, it remains below the probability estimates of the median forecaster and reinforces our view that the risk of recession remains moderate.”
While many have been concerned that the ongoing trade war between the U.S. and China could spark a recession, Goldman says that the trade war is “kicking the tires” of growth but likely won’t send send us into recession territory.
“Barring a large further escalation, we do not expect the trade war to cause a recession,” Daan Struyven and his team of economists wrote in a separate research note. “Further trade escalation would probably be required to generate enough downward pressure on growth to use a recession,” which the team says is “fairly unlikely because we expect the White House to want to avoid major disruption ahead of the election.”
Struyven and his team predict that the trade war will lower U.S. growth by about 0.25%, which is a relatively mild drop compared to the 2% decline seen during the 2008/2009 financial crash. The team also said that the Federal Reserve’s recent interest rate cuts have offset the damage, and “financial conditions have eased substantially on net this year.”