Goldman: Coming To A Fork In The Road

Goldman Sachs note that “the USD has continued to weaken on softer activity data, cooler inflation and some relaxation of banking sector stresses. It is clear from the March FOMC minutes that Fed officials were concerned that the bank failures could lead to a fairly sizable economic hit via tighter lending standards and a hit to sentiment.”

• “All of those look fairly manageable so far, and the question is increasingly how the March episode will weigh on markets and policymakers in coming months.”
• “Markets appear to be pricing a non-negligible risk of a steep downturn that would require deep Fed cuts, but a modal case that, if the Fed delivers just one more hike and is generally more convinced that policy is in restrictive territory already, tightening will come via a currency-negative pullback in credit availability, and a slow rebalancing is under way.”
• “While that modal outcome seems reasonable, we still think that is a narrow path to walk with inflation still elevated and more severe economic risks apparently receding somewhat. And it is worth noting that, while Fed officials were understandably concerned in March, most of the commentary since then has at least noted that the tightening in lending conditions appears mild so far and they continue to view the bank failures as relatively idiosyncratic.”
• “So, while the recent USD depreciation is understandable given the recent run of data, we continue to think the amount of divergence being priced in FX markets looks vulnerable. The market is pricing a fairly narrow path of a small slowdown but more accommodative policy, and we think that is likely to come to a fork in the road before too long.”