Goldman Sachs Warns: 500 Basis Point Spread May Force Powell's Policy Shift

Goldman Sachs has issued a warning that if the high-yield bond spread widens to 500 basis points, Federal Reserve Chairman Jerome Powell may be compelled to intervene and adjust his policy stance. This potential shift echoes Powell's actions in 2018, when he responded to similar market conditions by altering the Fed's approach. The current environment is marked by escalating global trade tensions, with President Trump's threats to increase tariffs on China prompting retaliatory measures from other nations. These developments have led to a risk-off mood in asset markets, driving investors towards safer havens such as government bonds.

The financial firm has also noted that the recent tariff announcements may have caused irreversible damage to the economy, increasing the likelihood of a recession even if Trump were to retreat from his current stance. This assessment comes as global equity markets have experienced significant declines, further fueling the flight to safety and exacerbating the risk-off sentiment. The plunge in equity markets has been attributed to the heightened trade tensions and the resulting uncertainty in the global economic outlook.

Goldman Sachs has also raised the odds of a U.S. recession to 45%, marking the second increase in a week. This revision reflects the firm's growing concerns about the economic impact of the ongoing trade disputes and the potential for further policy changes by the Federal Reserve. The firm has also lowered its U.S. economic growth outlook for 2025 to 1.3% from 1.5%, although this figure remains higher than the projections of other financial institutions. The combination of these factors suggests that the economic landscape is becoming increasingly volatile, with significant implications for both domestic and international markets.

According to Goldman Sachs analyst Lindsay Matcham's recent research report, if the credit spread further widens, coupled with the bond market pricing in a recession, it will prompt the Fed to take action. Typically, a widening credit spread may lead to difficulties in corporate financing, and the job market will subsequently weaken. If the high-yield bond spread continues to expand to 500 basis points, Powell is highly likely to intervene and change the policy stance as he did in 2018.

Powell's attitude was relatively hawkish last Friday, but this was mainly because the recent plunge in the U.S. stock market was event-driven, the nonfarm payrolls data remained strong, and given that tariffs could potentially drive up inflation in the future, he did not want to use policy "bullets" prematurely. However, the current high-yield bond spread has already reached 454 basis points, just a stone's throw away from the 500 basis point danger threshold.

The report only assigns a 51% probability to a rate cut at the May Fed meeting, indicating that the bond market needs further adjustment to prompt Powell to change the policy stance, which could potentially trigger a stock market rebound. The current high-yield bond spread has already reached 454 basis points, just a stone's throw away from the 500 basis point danger threshold. This suggests that the market is on the brink of significant changes, and any further widening of the spread could have profound implications for monetary policy and economic stability.