Goldman Sachs Global Economics Analyst Exhibit 10: Core PCE Inflation Will Likely Decline to 2.9% by End-2023 on Goods Disinflation and Slower Shelter Inflation in H2 Percent change, year ago Percent change, year ago 6 Contributions to Year-on-Year Core PCE Inflation 6 5 Supply-Constrained* 5 Other Goods GS Forecast 4 Travel 4 Other Services 3 Healthcare 3 Shelter 2 2 1 1 0 0 -1 9 19 9 0 20 0 1 21 1 2 22 2 3 23 3 4 24 4 -1 1 1 2 2 2 2 2 2 2 2 2 2 pr-Jul- pr- Jul- pr- Jul- pr-Jul- pr- Jul- pr- Jul- Jan-19A Oct-Jan-20A Oct-Jan-21A Oct-Jan-22A Oct-Jan-23A Oct-Jan-24A Oct- * New, used, and rental cars, furniture, sporting equipment, household appliances, sports and recreational vehicles, and video, audio, photo, and info. equipment. Source: Haver Analytics, Goldman Sachs Global Investment Research One might assume that our relatively optimistic inflation forecast translates into a relatively dovish Fed call. But that assumption would be wrong. The reason comes back to the interplay between real income and financial conditions. As real income recovers, a negative FCI growth impulse is required to keep growth below potential and continue rebalancing the labor market. However, the negative FCI impulse on sequential growth will likely diminish from its current drag of around 2pp annualized because it depends on the change in, rather than the level of, financial conditions (Exhibit 4, right panel). As a result, and even under our relatively optimistic inflation forecast, additional rate hikes of at least as much as markets are now pricing are likely required to keep the labor market adjustment going. Following the FCI easing over the past month, we now expect an additional 125bp of Fed rate hikes (vs. 100bp previously) with a downshift in the hiking pace to 50bp in December, and three smaller 25bp hikes in February, March, and now also May. Our new 5-5.25% peak funds rate is modestly above market pricing (Exhibit 11). 16 November 2022 9