Goldman Sachs: The Iran war is not enough to disrupt the inflation anchor, and the Fed is expected to hold steady throughout the year.

The US-Iran conflict continues to escalate, but Goldman Sachs believes that the impact of this war on US inflation is waning and is not enough to shake inflation expectations. The Federal Reserve is likely to keep rates unchanged this year.

According to Chase Wind Trading Desk, Goldman Sachs economists David Mericle and Pierfrancesco Mei pointed out in a research report released on July 12 that the shock to commodity prices has significantly receded, and the transmission effect on inflation is expected to weaken markedly in the third and fourth quarters.

Core PCE inflation will see a monthly increase of 24 basis points in June, and will stay within the range of 20 to 23 basis points thereafter. This path is sufficient for the Fed to remain on hold for the rest of the meetings in 2026, but there is extremely limited room for error.

The key premise of this judgment is that the conflict does not further escalate. If oil prices return to $100 per barrel, it would lead to an additional monthly increase of 3-4 basis points in core inflation. More importantly, a new round of supply shocks would exacerbate concerns about the loss of anchoring in inflation expectations, and its impact on monetary policy debates may far exceed the numbers themselves.

Commodity price shocks have reversed sharply

Although the US and Iran launched attacks on each other again last week, oil prices only rose moderately and are still about 30% below the wartime peak from late April to early May. Retail gasoline prices have fallen 15% from their peak, likely pulling down June CPI headline data; aviation fuel prices have dropped 35%, which will suppress air ticket prices in the coming months.

Other export commodities from the Persian Gulf have also fallen sharply from wartime highs. Prices for methanol, polyethylene, and nitrogen fertilizers are close to pre-war levels, with only sulfur and ammonia prices remaining elevated.

Shipping and air freight costs continue to rise, but the impact is limited. The report notes that international transportation costs account for only 1%-2% of US consumer goods import costs, and the current increase is much smaller than during 2021-2022. The impact on consumer prices is expected to be mild. Oil flows from Persian Gulf nations declined after the first tanker attack on June 27, but the 7-day average is still above the wartime low; while global observable oil inventories have not been replenished significantly, they are not at abnormally low levels either.

Inflation transmission effects will quickly dissipate in Q3 and Q4

Goldman Sachs uses two sets of statistical tools to assess the subsequent effects of the conflict on consumer prices.

The first tool is a model for the transmission of commodity prices to consumer prices, covering refined product spreads, transportation costs, and spillover effects from impacted economies. The model shows that the incremental impact of commodity prices on monthly core PCE inflation peaked in Q2; assuming no further escalation, it will decline significantly in Q3 and narrow further in Q4.

The second tool uses a scarcity index and supply chain stress indicators developed by Federal Reserve Board and New York Fed economists to assess broader disturbances outside of energy. Data show that the rise in these indicators during the Iran war was much less than during the pandemic, and had already declined noticeably from the peak before last week's new round of attacks. This model also shows that, barring further escalation, the impact of the conflict on monthly inflation already peaked in May-June, and will decline sharply in Q3 and Q4.

The impact of war is not enough to shake inflation expectations

The Fed officials’ main concern is that prolonged supply shocks could eventually unsettle inflation expectations. But current data indicates this risk remains within a controllable range.

The report notes that market-based inflation compensation indicators are still at moderate levels, which Fed Chair Walsh has recently emphasized; some consumer inflation expectation surveys (especially the University of Michigan survey) read high, but their reliability is increasingly questioned, as survey responses have become increasingly politicized and show less correlation with macroeconomic trends.

Composite indicators of persistent inflation risk send similar signals. This indicator tracks various paths by which an initial shock could develop into self-reinforcing high inflation, including normalization of business price expectations, rising inflation expectations, and wage-price spirals. The indicator suggests that, without further escalation, the inflation shock from this war is insufficient—in both severity and duration—to trigger inflation spread.

Inflation path supports the Fed staying on hold throughout this year

Based on the above analysis, core PCE inflation’s monthly increase is expected to record 24 basis points in June, then stay in the 20-23 basis points range in the subsequent months. Extra inflation pressure from tariffs and the overestimated AI demand will also gradually dissipate in the second half of the year.

On the annual level, it is expected that the US Bureau of Economic Analysis will implement a methodology adjustment in August, at which time year-over-year core PCE will drop by about 0.2 percentage points to 3.2%, but before the remaining Fed meetings this year, the yearly rate is likely to decline only slightly further.

This inflation path will allow the Fed to keep rates unchanged for the rest of 2026, although the tolerance is very limited, and there may be some internal disagreement within the FOMC.

If the conflict escalates again and pushes oil prices back up to $100 per barrel, models show monthly core inflation will rise an extra 3-4 basis points. However, the impact of a new round of supply shocks on monetary policy discussions may far exceed the numbers themselves—it would further exacerbate uncertainty over when supply disruptions will end, and intensify concerns that inflation expectations may eventually become unanchored.

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The above content is from Chase Wind Trading Desk.

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