Goldman Sachs says the market's expectations for Fed rate hikes are overly aggressive

Investing.com - Goldman Sachs is pushing back on market pricing for Federal Reserve rate hikes, arguing that traders are overestimating the risk that rising oil prices will force the central bank to tighten policy.

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Since the outbreak of the Iran war, the market’s probability of expecting the Fed to raise rates in 2026 has risen from 12% before the conflict to about 45%.

Goldman Sachs analyst Manuel Abecasis says this figure overstates the risks and cites four reasons why a rate hike is still unlikely.

Goldman Sachs believes the current supply shock is “smaller in magnitude and narrower in scope,” unlike past supply shocks that led to inflation problems. The firm notes that the economy’s reliance on oil is lower than in the 1970s, and the disruption is more limited than during the 2021-2022 supply chain crisis.

The firm also mentions that the economy started from a baseline that provides a buffer against broader price pressures.

The labor market is weakening, wage growth is below levels consistent with a 2% inflation rate, and inflation expectations remain stable. Goldman Sachs says these conditions make it unlikely that inflation will spread broadly into core inflation.

Goldman Sachs further points out that the federal funds rate is already 50 to 75 basis points above the Fed’s own estimate of the neutral rate, and that financial conditions have tightened by nearly 80 basis points since the start of the conflict.

The firm also finds that, based on historical data, there is no clear link between oil price shocks and the Fed’s tightening policy.

Abecasis wrote: “Our probability-weighted Fed forecasts are still clearly more dovish than what the market is pricing.”

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