Goldman Sachs Says Markets Are Wrong to Price In Fed Rate Hikes

Goldman Sachs strategist Dominic Wilson warned clients this week that bond markets have badly misread the Federal Reserve's likely response to the Iran war oil shock, calling out a swing in rate expectations that briefly put the probability of a year-end hike above 50%.

Futures markets, rattled by Brent crude surging more than 36% since the Iran conflict began on February 28, pushed the implied odds of a rate increase to 52% on March 27 per CME Group's FedWatch tool. By Monday morning, those odds had retreated to around 14%. The reversal was swift, but the underlying debate remains central to every rates desk in the building: is this an inflation event the Fed must fight, or a growth headwind it should accommodate?

Goldman's answer is unambiguous. "The market has priced a much larger hawkish shock than historical experience would suggest," Wilson wrote in a note to clients. The bank's core argument is that oil-driven inflation is a supply-side shock, not demand-driven overheating, and the Fed has historically tended to look through supply shocks rather than tighten in response to them. That logic is reinforced by a deteriorating macro backdrop: U.S. real GDP grew just 0.7% annualized in Q4 2025, February payrolls fell by 92,000, and unemployment hit 4.4%. Goldman economist Pierfrancesco Mei estimated in a March 26 note that the current oil price surge will reduce U.S. payroll growth by roughly 10,000 jobs per month through the end of 2026, with the unemployment rate expected to rise to 4.6% by Q3 2026.

Chair Jerome Powell's posture at the March 18 FOMC meeting, the second straight hold at 3.5% to 3.75%, confirmed the bind. Powell acknowledged that higher oil prices push inflation up and growth down at the same time, placing price stability and employment concerns on equal footing, signaling that rate cuts remain possible but are not imminent.

Wilson pointed to the 1990 Gulf War oil shock as the cautionary template. Markets priced aggressive tightening as energy costs spiked. The Fed moved in the opposite direction, cutting as the economy rolled over. "So we have precedent for the market leaning heavily on the risk of higher rates, and demanding a sizable risk premium, even though the Fed ultimately cut rates sharply in that episode," the strategists wrote.

Goldman's chief U.S. economist David Mericle has delayed the first expected cut to September from June, with a second cut in December, bringing the federal funds rate to 3% to 3.25% by year-end. The baseline assumes roughly six weeks of constrained Strait of Hormuz flows, with Brent crude averaging $105 per barrel in March and $115 in April before retreating to $80 by year-end.

For anyone at Goldman positioned around this call, the signals that will prove or break the thesis are straightforward. Five-year breakeven inflation rates are the early warning: if long-term expectations drift meaningfully above 2.5%, the supply-shock narrative cracks. Core PCE, sitting at 3.1% in January, needs to plateau rather than accelerate. Payroll and GDP prints over the next two quarters will show whether the slowdown deepens toward the recession threshold. And any shift in Powell's public language, particularly on the balance between upside inflation risk and downside employment risk, will reprice the front end faster than any data release.

Goldman raised its recession probability to 30%, up from 20% before the Iran war began, and lifted its headline PCE inflation forecast by 0.2 percentage points to 3.1% by December 2026, while nudging its full-year GDP growth estimate down to 2.1%. The bank still calls this a delay, not a reversal. Whether that distinction holds depends on how long the Hormuz flows stay disrupted and whether the growth data gives Powell any reason to revisit it.