Amid new evidence of a darkening economic picture, Goldman Sachs (GS: 77.78, -2.94, -3.64%) now forecasts that the economy will sharply contract this quarter and in the first quarter of 2009, resulting in the highest unemployment rate in more than two decades.
As a result of the worsening economic picture, Goldman predicts the Federal Open Market Committee will be forced to cut interest rates by another 0.5 percentage point to the lowest level since the 1950s.
“The main reason for these changes is the accumulation of evidence that U.S. domestic demand and production are dropping sharply,” Goldman said in its research note.
This week alone, there was a series of sobering economic reports released, including ones showing that the unemployment rate surged to a 14-year high, the nation has lost 1.2 million jobs in 2008, retailers posted their worst sales performance of the decade, U.S. auto sales plunged 15% from a month ago and the nation's manufacturing sector contracted to 26-year lows.
Goldman Sachs believes it will only get worse.
The firm now sees gross domestic product plunging 3.5% in the current quarter and 2% in the first quarter of 2009, up from its previous estimates of 2% and 1% respectively.
The steeper contraction in the economy will force employers to further slash jobs, bringing the nation’s unemployment rate from its current 6.5% level to 8.5% by the end of 2009, Goldman Sachs predicted. That would represent the highest level of unemployment since November 1983, according to the Bureau of Labor Statistics.
If the unemployment rate soars beyond 8.5%, as Goldman expects it will in 2010 as the economy struggles to grow, the trough-to-peak increase in unemployment would establish a new record in the post World War II era, the firm said.
Goldman also lowered its expectations of a recovery as it now sees GDP rising just 1.5% in the fourth quarter of 2009. “The point of this small adjustment is to emphasize that we do not see a resumption of anything close to trend growth before 2010.”
To fight this gloomy economic picture the Fed will likely cut the federal funds rate to 0.5% at its next meeting on December 16, “if not before,” Goldman predicted.
Goldman’s bleak forecast takes into account a $200 billion fiscal stimulus plan being enacted early next year. Congressional leaders and President-Elect Obama have expressed support for such a plan, though talks are just beginning.
House Speaker Nancy Pelosi called for a two-stage stimulus package, beginning with a $60 billion-to-$100 billion effort this month, The Wall Street Journal reported on Friday.
Obama is scheduled to detail his economic plans in a press conference later on Friday.
“We believe that the economy needs a large dose of federal spending and tax cuts, on the order of $300 billion to $500 billion,” Goldman wrote in the note. The firm also said prospects of a larger package have risen along with the worsening economic data and the election of Obama and more Democrats to Congress with a “clear mandate to fix the economy.”
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