Goldman Sachs delays Fed rate cut expectation to December ahead of Waller's debut

Goldman Sachs delays Fed rate cut expectation to December ahead of Waller's debut

The Powell era ends, and the specter of inflation forces Wall Street to reassess the Fed’s rate-cut path.

Federal Reserve Chair nominee Kevin Warsh is expected to be confirmed by the Senate on Monday and officially take over from Powell on May 15. However, he faces no easy start: ongoing Middle Eastern conflicts are pushing up energy prices, and the U.S. labor market remains robust—the Fed faces a scenario where “there’s no rate to cut.”

Goldman Sachs’s latest report has postponed its previously forecasted two rate cuts—from September and December 2026 to December 2026 and March 2027, respectively. The core reasons are: rising energy costs and persistent AI-related demand are collectively pushing the year-on-year growth rate of U.S. core Personal Consumption Expenditures (PCE) close to 3%. Meanwhile, the report has lowered the probability of a recession to 25%.

For investors, the “higher for longer” interest rate environment is returning, and the market has fully priced in rates staying at 3.50%–3.75% by year-end. Goldman warns that if the economy remains resilient, the Fed could indefinitely pause rate cuts, and investors should prepare for a “no rate to cut” scenario in the second half of 2026.

Multiple Factors Push Up Core PCE; Conditions for Rate Cuts Not Ready This Year

Against the backdrop of worsening inflation, the threshold for rate cuts has effectively been raised.

The transmission effect of energy prices, additional shocks related to the Middle East war, and AI demand’s impact on consumer prices (though this factor may be overestimated), are expected to bring the core PCE year-on-year closer to 3% rather than 2% for the full year. Even as the base effects from tariffs last year gradually fade from year-on-year calculations, the influence from energy transmission will persist through year-end.

Notably, many Fed officials had already made clear before the outbreak of war that they needed to see official inflation data closer to the 2% target before considering rate cuts. The upward shift in the inflation path will further bolster this camp, effectively raising the threshold for rate cuts.

Goldman expects that by the second half of 2026, as tariff and energy effects gradually wane, monthly core PCE will fall significantly on a sequential basis, with the annualized rate dropping below 2%. The conditions for rate cuts will ultimately be met, but will require more time.

Mixed Signals from Jobs Report; Fed Still Needs to Wait and See

The April jobs report sent complex signals and failed to provide a clear direction for rate cuts.

On the one hand, strong nonfarm payroll data raised monthly jobs growth trend estimates to about 51,000, returning to near the calculated breakeven rate—indicating employment expansion remains resilient and shows no signs of weakness necessitating policy easing. On the other hand, the unrounded unemployment rate rose by 0.08 percentage points, and the U6 broad unemployment rate rose by 0.2 percentage points—labor market slack is still progressing slowly, with some increase in idle capacity, leaving potential room for future rate cuts.

Due to soaring oil prices leading to economic activity below potential, and the possible resistance from AI, hiring is expected to be suppressed, and unemployment may rise to 4.6% by year-end. However, the report is cautious about this judgment: recent nonfarm data has persistently beaten expectations, and business surveys and early physical data after the war and oil shocks have remained resilient.

If the U.S. labor market fails to soften enough this year, the alternative forecast scenario is: the Fed will enact its last two rate cuts in 2027, by which time core inflation will likely have fallen to the 2% target.

Terminal Rate Unchanged, But “Permanent Pause” Risk Rises

Goldman’s latest forecast shows the terminal rate for this rate-cut cycle will land in the 3%–3.25% range. This is mainly based on the Fed officials’ estimates of the neutral rate having remained stable recently, and most still expect at least a few more rate cuts.

However, an undeniable risk scenario is emerging: if the economy remains robust all year at the current federal funds rate, some officials may raise their expectations for the neutral rate, concluding that no further rate cuts are needed.

The updated Fed scenario probability distribution is as follows:

  • Rate hike scenario (minor hike): probability 10%
  • Permanent hold (federal funds rate indefinitely unchanged): probability 25%
  • Base case (one cut each in December 2026 and March 2027): probability 40%
  • Recession scenario (recession in next 12 months): probability 25%, down 5 percentage points from before

Goldman’s rate path after probability weighting remains significantly more dovish than current market pricing. The main reason is that Goldman has virtually excluded any possibility of a rate hike—even as it factors in delayed or “permanent pause” scenarios for rate cuts.

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