Markets and central banks are both turning more hawkish; Goldman Sachs explores: How to hedge?

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The energy price shock, combined with the central banks’ hawkish turn, is reshaping global asset pricing logic, presenting investors with unprecedented hedging challenges.

Goldman Sachs strategists Dominic Wilson and Kamakshya Trivedi warn in their latest report that the hawkish repricing by markets and central banks has clearly overshot, interest rate pricing is significantly asymmetric, and front-end yields now offer attractive long opportunities in a variety of scenarios.

Meanwhile, as Federal Reserve officials release ambiguous signals that rates could either rise or fall, market expectations of an end to the rate-cut cycle are rising, further compressing the upside room for risk assets.

In terms of asset prices, the rates market is the most violently adjusted sector in this round of shocks, while stocks and credit markets have remained resilient overall so far and have yet to fully price in the deep downside tail risks. Goldman Sachs believes that in today’s environment with a wide range of scenarios, the primary task for investors is to selectively construct hedges while maintaining flexible positions.

Hawkish Repricing Has Clearly Overshot

The Goldman Sachs report points out that since energy prices surged, the hawkish repricing at the front end of the rates curve has been the most prominent feature of all market moves. Taking the UK as an example, market pricing swung from expecting a 54-basis-point rate cut this year to briefly pricing in a 102-basis-point hike; in Hungary, the outlook shifted from a 77-basis-point cut to a 118-basis-point hike. Before the situation eased on the 23rd, markets had priced in a 92-basis-point hike for the ECB, a 23-basis-point hike for the Fed, a 128-basis-point hike for Korea, and a 70-basis-point hike for Mexico.

Driving this aggressive repricing is not just energy prices themselves, but also unusually hawkish central bank statements. Fed Chair Jerome Powell explicitly stated that a mildly restrictive policy remains appropriate; there was no support for a rate cut on the Bank of England’s Monetary Policy Committee; several ECB officials publicly stated that the April meeting may discuss rate hikes.

According to the Wall Street Journal, there have been subtle but meaningful changes inside the Fed. Chicago Fed President Austan Goolsbee became one of the first officials to explicitly mention the possibility of further hikes, saying, "If inflation disappoints, I can imagine scenarios where we would need to hike rates." Previously viewed as dovish, Governor Christopher Waller also stated that inflation risks stemming from the Iran war led him to support holding rates unchanged in March. San Francisco Fed President Mary Daly warned that dot plots risk conveying "false certainty," and that there is no single most likely path for rates.

Central Banks May Be "Fighting the Last War"

Despite the strong momentum in hawkish repricing, the two Goldman strategists emphasize that this round of pricing has clearly exceeded reasonable ranges under most baseline scenarios, and make a core judgment: This aggressive repricing partly stems from "psychological scars" left by underestimating the 2022 inflation shock, and G10 central bankers’ acute focus on indirect effects, second-round effects, and de-anchoring of inflation expectations mirrors that period.

This round differs from 2022 in several important ways: the fiscal impulse is clearly weaker, any fiscal support is more targeted; the broad supply chain disruptions caused by the pandemic have not recurred; the labor market is notably weaker than the post-pandemic period.

Notably, emerging market central banks—typically more sensitive to inflation shocks—are now making relatively balanced statements, as seen in Brazil, Czech Republic, and Hungary. This is seen as one "signal" that hawkish pricing is excessive.

Meanwhile, according to Bloomberg, BMO Capital Markets’ US rates strategy chief Ian Lyngen also noted that the front end of sovereign yield curves no longer sees energy prices as following inflation risk, but rather focuses more on economic growth and downside risk to risk assets.

Recently, as oil prices continued to climb and US stocks faced sell-offs, US Treasury yields did not rise as usual but instead fell notably, an evident logical divergence. Some analysts argue that markets are more concerned about a deteriorating economic outlook.

From a fundamentals perspective, Fed rate hike risk pricing and repeated rate hike expectations in Europe are both overly hawkish, and front-end rates offer a clear, asymmetric opportunity for longs.

Front-End Rates: The Most Notable Asymmetric Opportunity

The asymmetry in rates markets has been the clearest change during this round, particularly attractive for investors who can withstand short-term volatility, whether by increasing long positions at the front end or extending portfolio duration.

Specifically, one can sell put options on European and UK front-end rates, with break-evens corresponding to multiple rate hikes; it is also worth incorporating hedges for deeper downside in rates (or related USD/JPY downside), as well as joint-scenario hedges where both rates and stocks fall, into medium-term risk management frameworks.

Historical experience from the 1990s shows that even if rate hikes ultimately prove excessive, yields rarely rebound significantly before energy prices fall clearly—although yields may peak before oil prices. This reinforces the logic for establishing longs at the front end now.

US Equities and Credit: Downside Tail Still Underestimated

Compared with the sharp adjustments in rates markets, US equity and credit markets have so far clearly underpriced deep downside tail risks.

Implied volatility of short-dated S&P 500 put options remains much lower than levels seen during the tariff shocks of April 2025, and is also below August 2024 when economic growth fears spiked. The experience of rapid policy reversal after the tariff shock has made investors more averse to downside hedges, but the path to resolution in the current situation is clearly more complex.

Given the convex nature of oil prices and uncertainty about growth outcomes, the deep downside tail in US equities and credit remains underestimated. The report suggests that under current baseline scenarios, maintaining or even increasing downside protection in equities, credit, and cyclical FX remains justified, while maintaining a positive view on long-term implied equity volatility.

As for options hedging, while upside call prices for US and European equities (and European FX) are expensive, they are not extreme compared with previous major declines; if upside is capped by pre-war concerns (AI disruptions, overstretched valuations, private credit turmoil), strategies such as call spreads remain reasonable.

Wide Scenario Distribution, Path Highly Uncertain

The core challenge facing markets now is that the scenario distribution is exceptionally wide, and small shifts in perception of tail risks can trigger violent two-way moves in asset prices.

In the optimistic scenario, rapid easing of tensions would first drive a rebound in those assets previously under the most pressure, including Europe and cyclical assets, non-USD currencies, and front-end rates; declines in Korean equities and the Hungarian forint may be among the first to be recovered.

In the pessimistic scenario, if oil prices surge further and trigger clear recession fears, risk assets will face broader shocks—assets that have shown relative resilience, like copper, the Brazilian real, and the Australian dollar, may not be spared, and in that case, haven G10 currencies such as the yen and Swiss franc could strengthen, with the focus of yields systematically shifting lower.

Along the spectrum, path-dependent partial recoveries may occur, but the terms-of-trade divergence in energy will show up more sharply between FX and equities; energy exporters’ assets (such as Brazilian equities and the Australian dollar) should still benefit relatively.

Furthermore, the pre-Iran-war accumulated concerns in the market—AI disruption expectations, high valuations, private credit volatility—have not dissipated. Once geopolitical tensions marginally ease, these issues may quickly return to the market’s focus, becoming major obstacles to any rebound.

Risk DisclaimerMarkets carry risks; investments require caution. This article does not constitute individual investment advice, nor does it take into account any user’s particular investment objectives, financial circumstances or needs. Users should consider whether any opinions, viewpoints or conclusions in this article are applicable to their specific circumstances. Investing based on this information is at your own risk. ```