Because of high oil prices, will the Fed raise interest rates? Goldman Sachs doesn't believe it.
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According to Zuifeng Trading Desk, on April 1, Goldman Sachs economist Manuel Abecasis published a research report stating that although market expectations for Fed rate hikes surged following the outbreak of US-Iran conflict, the Fed is actually unlikely to raise rates.
The report emphasizes that if the economy falls into recession, the Fed will most likely still cut rates, and shocks in oil prices won’t stop its easing actions. The main reasons are fourfold:
The current oil shock is smaller in scale and scope: Compared with the 1970s, the current rise in oil prices is less significant, and today’s economy is much less dependent on oil.The economic starting point is different, and inflation is hard to spread: The labor market is softening, wage growth is already below the level consistent with the 2% inflation target. Long-term inflation expectations are stable, unlike the uncontrolled expectations in the 1970s.Monetary policy is already tight: Since the conflict began, financial conditions have tightened by about 80 basis points, further reducing the need for additional tightening policies.The Fed usually does not respond to pure oil shocks: Historical analysis shows there is no significant correlation between mentions of oil shocks in Fed officials' speeches and signals of tighter policy, whereas ECB officials show stronger correlation.
Goldman’s baseline forecast remains two rate cuts in 2026, and its probability-weighted rate path prediction is more dovish than the market pricing.
The scope and scale of this round of oil price shocks are far less than historical crises
Manuel Abecasis pointed out that even under the "severely adverse scenario", the extent of this oil price shock is still less than the 1970s, and its duration is shorter than in 2021–2022.
More importantly, the US economy’s dependence on oil is now much lower than in the 1970s. Data show that the energy intensity of GDP and gasoline’s share of Personal Consumption Expenditures (PCE) have both declined significantly compared to back then.
At the supply chain level, although the Iran conflict may disturb Middle Eastern trade routes and prices of some non-oil commodities, so far its impact is clearly less extensive than the large-scale supply disruptions and commodity shortages seen in 2021–2022. Of course, as the conflict continues, there remains uncertainty regarding supply chain prospects.
From the inflation transmission path, the rise in oil prices will significantly push up headline inflation, but its impact on core inflation is relatively limited, and this shock will fade over time since oil prices don’t rise year after year.
Meanwhile, higher oil prices will depress real disposable income, dragging economic growth and employment. Goldman expects the unemployment rate to rise to 4.6% in 2026; and if oil prices rise further, unemployment will rise even more.
Previous mainstream economic research also believes that central banks should "ignore" the short-term shocks of energy prices, for similar reasons as tariffs. Since oil price shocks are temporary and also suppress demand, tightening monetary policy would only worsen labor market damage and be almost useless for controlling inflation.
This is also one of the reasons why the Fed and other major central banks focus more on core inflation than headline inflation.
Economic fundamentals lack "fuel," risk of secondary inflation spread is low
Goldman emphasizes that the current macro environment makes large-scale secondary inflation effects extremely unlikely.
Looking back, periods of severe inflation in the 1970s and 2021–2022 had one thing in common: an extremely tight labor market and accelerating wage growth.
In the 1970s, such overheating had lasted for years before the first major oil shock in 1973; the expansionary fiscal policy of the 1960s made the economy enter the 1970s in an overheated state; the large-scale fiscal stimulus of 2020–2021 played a similar role.
In contrast, the current US labor market is softening, wage growth is below the level consistent with a 2% inflation target, and medium- to long-term inflation expectations remain well anchored.
Through modeling G10 country data, Goldman believes that when the labor market is relatively loose, long-term inflation expectations are anchored, and fiscal policy is not expansionary, the likelihood of supply-side shocks causing persistent core inflation rises is significantly reduced.
Monetary policy is more neutral, and the bar for rate hikes is higher
The starting point for current monetary policy is completely different from the two previous major inflation events.
Currently, the Fed's federal funds rate is estimated to be 50–75 basis points above the median neutral rate estimate in the Fed's Summary of Economic Projections (SEP), and is roughly in line with the recommendations of standard policy rules.
In contrast, at the start of 2021–2022, the federal funds rate was at zero, far below the neutral rate; similarly in the 1970s, policy rates were well below neutral and policy rule recommendations.
In addition, since the conflict began, financial conditions have tightened by about 80 basis points, further reducing the need for proactively tightening monetary policy.
The Fed has never raised rates merely due to oil price shocks in its history
Historical analysis by Goldman shows Fed officials mentioning oil shocks are not significantly correlated with signals of policy tightening, whereas ECB officials are more strongly correlated.
According to FOMC scenario analysis by Fed staff, in scenarios of rising oil prices, staff forecasts typically show: higher headline inflation, slight rise in core inflation, lower economic growth, higher unemployment, but no change in fed funds rate compared to baseline forecasts.
At the same time, neither FOMC members nor the Fed Chair have ever systematically raised policy rate forecasts due to oil price shocks in history.
Furthermore, historical data show that in recessions preceded by oil price spikes, the FOMC cut policy rates by about 3.5 percentage points. Goldman has currently raised the probability of recession in the next 12 months by 10 points to 30%, and expects the Fed to begin cutting rates if recession arrives.
Overall, Goldman believes the current situation is intrinsically different from the "high risk" settings of the 1970s and 2021–2022.
Whether in terms of the scale and scope of supply shocks, the starting point of economic fundamentals, the initial stance of monetary policy, or the Fed’s historical response, the threshold for rate hikes this time is far higher than implied by current market pricing.
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