Because of high oil prices, will the Federal Reserve raise interest rates? Goldman Sachs doesn't believe so.

Wall Street Insights

Goldman Sachs economist Manuel Abecasis believes that the current oil price shock is much smaller in scale than those in the 1970s, and that the economy’s dependence on oil has significantly decreased; currently, there is a lack of conditions for a secondary inflationary spread; monetary policy has already started from a relatively tight stance; historically, the Federal Reserve has never raised interest rates solely due to oil price shocks. Goldman Sachs maintains a baseline forecast of two rate cuts by 2026.

According to Wind Trading Desk, on April 1, Goldman Sachs economist Manuel Abecasis published a research report stating that although market expectations for Fed rate hikes surged after the outbreak of the US-Iran conflict, it is unlikely that the Fed will actually raise rates.

The report emphasizes that if the economy enters a recession, the Fed is highly likely to cut rates, and the oil price shock will not prevent its easing measures. The main reasons are fourfold:

• The current scale and scope of the oil shock are smaller: compared to the 1970s, the current oil price increase is less significant, and the economy’s dependence on oil has greatly diminished.
• Different starting points for the economy mean less inflation contagion: the labor market is softening, wage growth is below the level consistent with the 2% inflation target, and long-term inflation expectations remain stable, unlike the runaway expectations in the 1970s.
• The starting point of monetary policy is already relatively tight: since the conflict began, financial conditions have tightened by about 80 basis points, further reducing the need for additional tightening.
• The Fed generally does not react to pure oil shocks: historical analysis shows that Fed officials’ comments about oil price shocks are not significantly linked to signals of tightening policy, whereas ECB officials show a stronger correlation.

Goldman Sachs’s baseline forecast remains for two rate cuts by 2026, with a probability-weighted interest rate path that is more dovish than market pricing.

The scale and breadth of this oil price shock are far less than those during past crises

Manuel Abecasis points out that even under a “severely adverse scenario,” the magnitude of this oil price shock is still smaller than in the 1970s, and its duration is shorter than that of 2021-2022.

More importantly, the current US economy’s dependence on oil is much lower than in the 1970s. Data shows that energy intensity of GDP and the share of gasoline in personal consumption expenditures (PCE) have declined significantly since then.

On the supply chain front, although the Iran conflict may disrupt trade routes in the Middle East and cause some non-oil commodity prices to fluctuate, so far, its impact scope is clearly narrower than the large-scale supply disruptions and commodity shortages during 2021-2022. Of course, as the conflict persists, supply chain outlook remains uncertain.

From the perspective of inflation transmission, rising oil prices will significantly push up overall inflation, but their impact on core inflation will be relatively limited, and this shock will fade over time because oil prices are unlikely to continue rising year after year.

Meanwhile, higher oil prices will reduce real disposable income and weigh on economic growth and employment. Goldman Sachs forecasts that the unemployment rate will rise to 4.6% by 2026; if oil prices rise further, the increase in unemployment will be even larger.

Previous mainstream economic research also suggests that central banks should “ignore” short-term energy price shocks, similar to tariff shocks. Because oil price shocks are temporary and tend to suppress demand, tightening monetary policy would only worsen labor market damage and is almost useless for controlling inflation.

This is also one reason why the Fed and other major central banks focus more on core inflation than headline inflation.

The macroeconomic fundamentals lack “fueling” conditions, making the probability of secondary inflationary spread low

Goldman Sachs emphasizes that the current macro environment makes the occurrence of large-scale secondary inflation effects extremely unlikely.

Looking back at history, periods of severe inflation in the 1970s and 2021-2022 share a common feature: an extremely tight labor market with accelerating wage growth.

In the 1970s, this overheating had already persisted for years before the first major oil shock in 1973; expansionary fiscal policies in the 1960s further pushed the economy toward overheating; similarly, the large fiscal stimulus in 2020-2021 played a comparable role.

In contrast, the US labor market is softening now, with wage growth below the level consistent with the 2% inflation target, and medium- to long-term inflation expectations remain well-anchored.

By modeling data from G10 countries, Goldman Sachs believes that when the labor market is relatively slack, long-term inflation expectations are anchored, and fiscal policy is less expansionary, the likelihood of supply shocks causing persistent core inflation increases is significantly reduced.

The starting point of monetary policy is more neutral, with a higher hurdle for rate hikes

The current monetary policy starting point is very different from the two previous major inflation episodes.

Currently, the Federal Funds rate is 50-75 basis points above the median estimate of the neutral rate in the Fed’s Summary of Economic Projections (SEP), roughly aligning with standard policy rules.

In contrast, at the beginning of 2021-2022, the Fed funds rate was at zero, well below the neutral rate; similarly, in the 1970s, policy rates were far below neutral levels and the suggested levels of policy rules.

Additionally, since the outbreak of the conflict, financial conditions have tightened by about 80 basis points, further reducing the need for active tightening.

The Fed has never historically raised interest rates solely due to oil price shocks

Goldman Sachs’s historical analysis shows that Fed officials’ comments about oil price shocks are not significantly linked to signals of tightening policy, whereas ECB officials show a stronger correlation.

From scenario analyses of Fed staff reports to the FOMC, in an oil price increase scenario, forecasts typically show: overall inflation rising, core inflation rising slightly, economic growth slowing, and unemployment rising, but the federal funds rate remaining close to the baseline forecast.

Meanwhile, neither FOMC members nor the Fed chair have systematically increased policy rate forecasts in response to oil shocks in history.

Additionally, historical data shows that during previous recessions preceded by rising oil prices, the FOMC cut the policy rate by about 3.5 percentage points. Goldman Sachs has now increased the probability of a recession in the next 12 months by 10 percentage points to 30%, and expects the Fed to start cutting rates once a recession occurs.

Overall, Goldman Sachs believes that the current situation is fundamentally different from the “high-risk” environments of the 1970s and 2021-2022.

In terms of supply shocks’ scale and scope, the starting point of economic fundamentals, initial monetary stance, and the Fed’s historical responses, the threshold for rate hikes in this cycle is much higher than what the market currently prices in.

All the above insights are from Wind Trading Desk.

For more detailed analysis, including real-time commentary and frontline research, please join the 【Wind Trading Desk ▪ Annual Membership】.

Markets are risky; invest cautiously. This article does not constitute personal investment advice and does not consider individual users' specific investment goals, financial situations, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Invest at your own risk.

			
			
			

			

			
			

			
			
			
			

            
            
            

                

                

Massive information, precise analysis, all on Sina Finance APP

            

            

            

			
			

Editor: Guo Jian