Hormuz Strait Closure Impact Limited, US Recession Probability Drops to 25%

Overview

Written by Goldman Sachs Chief Economist Jan Hatzius, titled 'Global Outlook: Bent but Not Broken'. The report analyzes the performance and outlook of major global economies amidst geopolitical conflicts (specifically the 10-week closure of the Hormuz Strait). The core conclusion is: Despite supply shocks, the global economy has not collapsed, and US recession risk has slightly decreased to 25% due to economic activity resilience and eased financial conditions. However, growth prospects remain below trend levels, and inflation exhibits stickiness due to statistical biases and energy price pass-through, leading to delayed Fed rate cuts. The report also notes worsening structural imbalances in China's economy, significant room for RMB appreciation, and recommends investors hedge tail risks while maintaining exposure to US equities via tools such as options.

Core views

US Economic Resilience and Recession Risk: Despite first-quarter GDP growth missing expectations, real private domestic final sales grew by 2.5%, indicating solid underlying demand. Labor market data exceeded expectations, with nonfarm payrolls increasing by 115,000 in April and the unemployment rate stabilizing at 4.3%, while initial jobless claims fell significantly. Based on this, Goldman Sachs lowered the US 12-month recession probability from 30% to 25%. However, this risk level remains 5 percentage points above pre-war levels and 10 percentage points above the long-term average. As the cash flow boost from tax refunds dissipates, combined with persistent headwinds from high oil prices, slowing nominal wage growth, and reduced healthcare subsidies, consumer real disposable income and cash flows are weakening. Personal savings rates have fallen to a three-year low of 3.6%, expected to dampen subsequent consumer spending. Inflation Stickiness and Statistical Bias: The AI boom has introduced two distortions into core PCE inflation. First, companies like Microsoft have increased bundled prices after adding AI features to software packages; official statistics fail to exclude the value of new features, mistakenly judging it as a pure price increase. Second, the weight of software and accessories in PCE is 30 times that of CPI, potentially erroneously including demand from small businesses. These distortions are expected to raise year-over-year core PCE inflation by 0.4 percentage points later this year, combined with the 0.3 percentage point contribution from energy price pass-through, delaying the disinflation process of core PCE. In the long run, as rental inflation slows (due to overbuilding of apartments) and the labor market cools (nominal wage growth at 3.6%, unit labor costs rising only 1.2%), core PCE month-over-month inflation could return to 2% by late 2026, but year-over-year target values may not be reached until mid-2027. Monetary Policy and Global Central Banks: Given upside surprises in inflation, strong labor data, and hawkish tendencies within the FOMC, Goldman Sachs has delayed its prediction of two 25-basis-point normalized rate cuts by the Federal Reserve to December 2026 and March 2027, though still below market pricing. Regarding the transition in Federal Reserve leadership, while Kevin Warsh's early calls for rate cuts driven by deflation from AI were not widely accepted, his recent advocacy for using a 'trimmed-mean PCE' that is insensitive to one-off price shocks as a measurement metric is more persuasive and may be more openly adopted by the new chairman. In Europe, the European Central Bank is expected to raise rates by 25 basis points in June and September, primarily due to low starting deposit rates and an excessive reaction to oil-price-driven headline inflation. However, healthy core inflation creates a risk that no hikes occur, and any recent hikes might be reversed in 2027. Under the base case, the Bank of England will not raise rates, but there are hawkish risks. China and Exchange Rates: China's economy benefits from strong export-oriented manufacturing, with Q1 GDP growing 5.0% year-over-year; the full-year forecast remains at 4.7%. However, the economy is extremely unbalanced, with strong production coupled with weak demand, and the current account surplus as a share of global GDP is expected to reach a new record high. Goldman Sachs FX strategists believe the RMB is severely undervalued, with a gap exceeding 20% against the dollar, maintaining a significant appreciation forecast for the RMB with a 12-month target price set at 6.50. US Stock Valuations and Strategy: Despite multiple risks including fiscal deficits, demographic shrinkage, and geopolitical tensions, and noting that the stock market is not cheap, US equities have performed strongly. The main reasons are strong first-quarter earnings and the AI revolution improving long-term productivity and profit prospects. According to Goldman Sachs strategists, earnings and dividends occurring ten years or more from now account for approximately 75% of intrinsic value in the US market. Given a positive base case scenario but highly asymmetric risks, the recommendation is to combine long equity positions with equity volatility exposure or significant hedging (such as deep out-of-the-money put options).

Analysis framework

Goldman Sachs employs a typical approach combining macro scenario analysis with fundamental breakdown. First, by decomposing the impact of geopolitical shocks (closure of the Hormuz Strait) on oil prices, physical shortages, and policy responses, they assess the marginal damage to global growth. Second, when analyzing US recession risks, they look beyond headline GDP, deeply breaking down private domestic final sales and micro-level labor market data (e.g., nonfarm payrolls, unemployment rate, initial jobless claims), combined with the financial conditions index for comprehensive judgment. In inflation analysis, the report specifically introduces a critical perspective on statistical methodology, pointing out biases in CPI/PCE statistics regarding AI product bundling, a detail rarely covered in traditional macro analysis. Additionally, the report uses productivity trend analysis (comparing pre- and post-pandemic periods) to derive the break-even employment level under the natural rate of unemployment, explaining why seemingly strong employment growth did not further push down the unemployment rate. Finally, through valuation decomposition (the proportion of discounted future earnings), they explain the rationality of US stocks at high valuations and propose hedging strategies under asymmetric risks.

Methodology notes

• Cycle and Sentiment FrameworkSentiment Inflection Point Analysis

  Dynamic Adjustment of Recession Probability

  Institutions dynamically adjust probability estimates for future economic recessions based on the latest high-frequency economic data (e.g., employment, sales) and changes in financial conditions, rather than taking a static view.

• Industry/Industrial Analysis FrameworkVolume-Price Breakdown

  Structured Decomposition of Inflation Sources

  Decomposing overall inflation into categories such as energy, rent, wages, and specific goods (e.g., software) to analyze their respective supply-demand drivers and statistical weights, identifying temporary fluctuations versus trend changes.

• Quantitative/Factor/Portfolio TheoryBeta/alpha analysis

  Hedging Configuration under Asymmetric Risks

  When the market base-case expectation is positive but huge tail risks exist, it is recommended to manage asymmetric risks by holding underlying assets (Beta) while purchasing deep out-of-the-money options (protective puts).

• Company Fundamentals and Financial FrameworkOperating/Financial Leverage Analysis

  Impact of Productivity on Employment Absorption Capacity

  Analyzing how technological progress (such as AI) improves total factor productivity, leading to reduced incremental employment required for the same GDP growth, thereby affecting judgments on the number of new jobs needed for 'full employment'.

Key data

• US 12-Month Recession Probability25%Lowered from previous 30%, but still above long-term average
• US Private Domestic Final Sales Growth2.5%First-quarter real growth rate, indicating solid domestic demand
• US Personal Savings Rate3.6%Fell to three-year low level
• Core PCE Inflation Increase Magnitude0.7ppIncluding 0.4pp contribution from AI software statistical bias and 0.3pp from energy price pass-through
• Fed Rate Cut Prediction TimingDecember 2026, March 2027Two 25-basis-point rate cuts, delayed compared to prior forecasts
• RMB to USD Exchange Rate Target6.5012-month forecast value, implying significant appreciation
• US Stock Forward Value Share75%Proportion of earnings and dividends occurring ten years or more later relative to current intrinsic value

Impact & implications

For investors, the report implies that while an immediate collapse was avoided, the path to a 'soft landing' remains rough. Inflation stickiness means the high-interest-rate environment will persist longer, putting pressure on the bond market and growth stock valuations. The significant appreciation expectation for the RMB may attract capital inflows back into Chinese assets, but caution is needed regarding structural issues of weak internal demand in China's economy. For US stock investors, the report warns that current optimism is fully priced in, and any negative surprise could lead to sharp volatility; therefore, simple long positions are no longer the optimal strategy, and tail-risk protection must be equipped.

Risks

• Delayed reopening of the Hormuz Strait or escalation of conflict, leading to a significant spike in oil prices
• Sharp contraction in consumer spending due to weak income, triggering a deep recession
• Fed policy error, either overly tight or loosening too late
• Deterioration of geopolitical risks (China-US competition, war in Europe)
• Breakout of AI security vulnerabilities or cyber security incidents

What to watch

• Progress of Hormuz Strait reopening and oil price trends
• Changes in software and accessories components within US core PCE inflation
• Discussions on inflation measurement metrics (e.g., trimmed-mean PCE) during the Federal Reserve leadership transition
• Changes in China's current account surplus as a share of global GDP
• Continued performance of US labor market productivity data