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Higher for longer rates will cause 'drag on GDP' for longer: Economist

Markets continue to digest the Federal Reserve's "higher for longer" interest rate policy as the Fed continues in its attempts to reach its 2% inflation goal. In a recent note, Goldman Sachs Chief Economist Jan Hatzius warns this new regime will cause GDP growth to slow, expecting half a percentage point hit on growth over the next year.

Yahoo Finance hosts Seana Smith and Bradley Smith break down comments from Hatzius and David Kostin, Goldman Sachs' U.S. Chief Equity Strategist.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Video Transcript

- Goldman Sachs chief investment officer David Kostin and his team believe margins for S&P 500 companies should contract moderately in 2023 and expand again through 2025. The investment banking giant, reiterating its S&P 500 EPS estimate of $224 for 2023. Now Kostin expects a forecast of $250 for 2025 here. And so that is perhaps one of the movements that we can keep an eye on here.

- It will be. And, Brad, we're also keeping a close eye on what Goldman Sachs' Jan Hatzius is saying. Now he sees a risk here from the higher for longer regime. Now in his most recent note out today, the economist saying that the main implication of the further tightening in financial conditions is that the drag on GDP growth is going to last longer. And talking about exactly what that means, he's now expecting roughly a half of a percentage point hit to growth over the next year, saying that it's still too small to threaten a recession.

But he's highlighting some of the issues, obviously, that we know are on investors' radar when we're talking about this higher for longer environment right now, what that means for the equity market, and what that means here for potential returns over the coming quarters.

- Yeah, higher for longer shows up in a few different ways. And as the Fed has continued to discuss and evaluate where that could show up in consumer confidence, and think about a longer played out weight of the recession risk on consumer here, and where that would show up in everything from everyday purchases, and perhaps a dumbing down or a dampening even more of some of those discretionary purchases, all the way up to the largest purchases that you need to get financed, whether that be vehicles, the Fed has talked about that.

Whether that be homes, and continuing to see fracture in the housing market, Fed has discussed that. So all of these things considered, that longer for-- higher for longer has longer term implications. But then at the same time, a lot of the economists that we've kind of discussed this matter with, as well, have kind of put in context for us, thinking 20 years back even. That even though this is higher for longer, this is higher for longer relative to where we were at before, and what we were expecting, and what we were hoping for in terms of a more rosy rate environment here.

Remember, rates dropped dramatically, why? Because of the GFC, the great financial crisis thereafter. And some of the market moves made to then be able to stir or, at least, bring about even more of that consumer confidence and reemerge both in housing, as well, as even into some of those discretionary categories, then later on, after that starts to be able to be hiked incrementally, then you have the COVID pandemic, which is a great reset at that point of some of the rate environment, all the way back to zero.

Amazing lending environment, as well, that had to take place and for good reason to make sure that the economy did have enough stimulus, did have enough that was still taking place from the consumer mindset. But now, us getting back towards, perhaps, what we haven't seen in the latter part of 15 years, at this point in time, of a stabilized rate at this level or higher, that's something that consumers are going to, at least, at this point, it seems from some of these economists have to get used to.

- Yeah. And, Brad, to that point, here just the unique situation right now. I think that's also why we have forecasters almost all over the map, just in terms of what the next couple of quarters are going to look like. We're almost in an unprecedented time right now when we talk about that higher for longer, given where we are in the economic cycle. And also given the reaction that we've seen to these higher rates up until this point. Certainly, when we started the year, there were many calls for a recession.

By this time in the year, we have seen consumers remain resilient. They go out. They continue to spend, although, their spending patterns have shifted. But we are certainly trying to figure out what exactly this higher for longer is. And still though, even though we could be in this period for longer than we initially anticipated, many and [? Yam ?] being one of those people out there, still thinking that there's a possibility that we'll be able to avoid a recession. You know what I'm saying?

- Yeah, indeed.