4 Reasons Why Goldman Sachs Thinks Fed Rate-Hike Odds Are Too High
After months of investors betting on rate cuts, the narrative around the Federal Reserve recently shifted to rate hikes.
Goldman Sachs disagrees with the hawkish pivot, and says expectations for rate hikes are misplaced.
The firm notes that the market is now assigning a roughly 45% chance to the Fed hiking rates in 2026, up from just 12% prior to the Iran war.
“Our summary indicator of these metrics suggests that the risk of persistent inflation and rate hikes from a supply shock is much lower now than in either the 1970s or 2021-2022,” Goldman wrote.
The firm’s baseline forecast instead includes two cuts in 2026, while its probability-weighted Fed outlook is much more dovish than the market it pricing in.
Here are four reasons Goldman says the market’s Fed rate hike fears are overblown.
1. The current oil shock is less significant than past cases
Goldman said that the current oil supply shock driven by the ongoing conflict in the Middle East is less impactful than other instances through out history.
“The current supply shock is smaller and narrower than prior shocks that caused inflation problems,” they wrote.
The analysts compared today’s oil price spikes to the 1970s when the conflict in the Middle East drove triple digit rises in oil prices as well as the global supply chain disruption of the Covid pandemic.
They said both the oil price increase and the supply chain disruptions are less significant today.
2. A softening labor market and slow wage growth will cushion inflation impact
“The economy’s starting point makes large spillovers to broader inflation unlikely,” the analysts wrote.
They outlined that the softening labor market, wage growth that is lower than consistent with the Fed’s target inflation rate, and “well-anchored” inflation expectations make it so that an oil shock large enough to trigger inflation concerns would mean a recession.
Goldman noted that in the 1970s and in 2021-2022, inflation surged amid a tight labor market and rapid wage growth. They explained that core inflation is more likely to accelerate after an oil shock in a tight labor market when wages are growing.
3. Current Fed rates are roughly in line with baseline levels
Another factor is where Fed rates sit today. The Fed’s current monetary policy rate is broadly in line with the prescription of standard policy rules, Goldman said.
They added that financial conditions have tightened since the start of the war in Iran further reducing the need for tightening monetary policy.
In contrast, rates were zero in early 2022 and below the neutral rate per policy rule prescription in the 1970s.
4. The Fed doesn’t typically change rates on oil price shocks
Finally, Goldman noted that it’s atypical for the Fed to tighten rates due to oil shocks alone.
“We find no meaningful relationship between mentions of oil price shocks and tighter monetary policy in speeches by Fed officials,” the analysts said.
They added that the FOMC’s projections on higher oil price scenarios include no change to the policy rate relative to the baseline.
