Goldman Sachs economist Manuel Abecasis argues that the current oil price shock is significantly smaller in scale than that of the 1970s, and the economy's dependence on oil has greatly diminished. Conditions for a secondary inflation spread are lacking, monetary policy is already relatively tight, and historically the Federal Reserve has never raised rates solely due to an oil price shock. Goldman Sachs maintains its baseline forecast of two interest rate cuts in 2026.
On April 1, Goldman Sachs economist Manuel Abecasis stated in a research report that despite a sharp increase in market expectations for Federal Reserve rate hikes following the outbreak of U.S.-Iran conflict, an actual rate hike is unlikely.
The report emphasizes that if the economy falls into a recession, the Fed would most likely still cut rates, as an oil price shock would not prevent it from easing. This view is based on four main reasons:
The scale and scope of the current oil shock are smaller: Compared to the 1970s, the current rise in oil prices is more modest, and the economy's reliance on oil is substantially lower today. The economic starting point is different, making widespread inflation unlikely: The labor market is softening, with wage growth already below levels consistent with a 2% inflation target. Long-term inflation expectations remain stable, unlike the runaway expectations seen in the 1970s. Monetary policy is already relatively tight: Financial conditions have tightened by approximately 80 basis points since the conflict began, further reducing the need for additional policy tightening. The Fed typically does not react to pure oil price shocks: Historical analysis shows no significant correlation between Fed officials mentioning oil price shocks and signaling tighter policy. In contrast, European Central Bank officials show a stronger correlation.
Goldman Sachs' baseline forecast remains two rate cuts in 2026, with its probability-weighted interest rate path projection being more dovish than current market pricing.
The scale and breadth of the current oil price shock are far less severe than historical crises. Manuel Abecasis pointed out that even under a "severely adverse scenario," the magnitude of the current oil price shock is smaller than in the 1970s, and its duration is shorter than the 2021-2022 episode.
More importantly, the U.S. economy's current dependence on oil is significantly lower than in the 1970s. Data show that both the energy intensity of GDP and the share of gasoline in personal consumption expenditures (PCE) have declined markedly since then.
On the supply chain front, while the Iran conflict may cause disruptions to trade routes in the Middle East and affect prices of some non-oil commodities, its impact so far is notably narrower than the large-scale supply disruptions and goods shortages seen during 2021-2022. However, uncertainty remains regarding the supply chain outlook as the conflict persists.
Regarding the inflation transmission path, rising oil prices will significantly boost headline inflation but have a relatively limited impact on core inflation. Furthermore, this shock will fade over time as oil prices are unlikely to keep rising year after year.
Meanwhile, higher oil prices will reduce real disposable income, dampening economic growth and employment. Goldman Sachs expects the unemployment rate to rise to 4.6% in 2026; a further increase in oil prices would lead to an even larger rise in unemployment.
Mainstream economic research has long held that central banks should "look through" temporary energy price shocks, similar to tariff shocks. Since oil price shocks are typically temporary and also suppress demand, monetary tightening would only worsen labor market damage without providing meaningful inflation control.
This is one reason why the Federal Reserve and other major central banks focus more on core inflation than headline inflation.
Lack of fundamental "fuel" for a secondary inflation spread is unlikely. Goldman Sachs emphasizes that the current macroeconomic environment makes a significant secondary inflation effect highly improbable.
Historically, periods of severe inflation in the 1970s and 2021-2022 shared a common feature: an extremely tight labor market with accelerating wage growth.
In the 1970s, this overheating condition had persisted for years before the first major oil shock in 1973. Expansionary fiscal policies in the 1960s had already pushed the economy to the brink of overheating entering the 1970s. Large-scale fiscal stimulus in 2020-2021 played a similar role.
In contrast, the current U.S. labor market is softening, wage growth is below levels consistent with the 2% inflation target, and medium-to-long-term inflation expectations remain well-anchored.
Based on modeling data from G10 countries, Goldman Sachs believes that when labor markets are looser, long-term inflation expectations are anchored, and fiscal policy is less expansionary, the probability of a supply-side shock causing a persistent rise in core inflation is significantly reduced.
Monetary policy starting point is more neutral, raising the bar for hikes. The current starting point for monetary policy is fundamentally different from the past two major inflation episodes.
The current 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) and is broadly in line with standard policy rule recommendations.
In contrast, at the beginning of 2021-2022, the federal funds rate was at the zero lower bound, significantly below the neutral rate. Similarly, in the 1970s, policy rates were far below neutral levels and policy rule suggestions.
Furthermore, financial conditions have tightened by about 80 basis points since the conflict began, further reducing the necessity for proactive monetary tightening.
The Fed has never historically raised rates solely due to an oil price shock. Goldman Sachs' historical analysis shows no significant correlation between Fed officials mentioning oil price shocks and signaling tighter policy, whereas a stronger correlation exists for ECB officials.
Based on scenario analyses presented by Fed staff to the FOMC, under oil price rise scenarios, staff forecasts typically show: higher headline inflation, a slight increase in core inflation, lower economic growth, and higher unemployment, but the federal funds rate path remains unchanged relative to the baseline forecast.
Moreover, neither FOMC participants nor Fed Chairs have historically systematically raised their policy rate projections in response to oil price shocks.
Historical data also show that in recessions preceded by oil price spikes, the FOMC has typically cut the policy rate by about 3.5 percentage points. Goldman Sachs has raised its probability of a recession within the next 12 months by 10 percentage points to 30% and expects the Fed to start cutting rates if a recession occurs.
Overall, Goldman Sachs believes the current situation is fundamentally different from the "high-risk" backgrounds of the 1970s and 2021-2022.
Whether judged by the scale and scope of the supply shock, the starting point of economic fundamentals, the initial stance of monetary policy, or the Fed's historical reactions, the threshold for rate hikes in this cycle is significantly higher than what is currently reflected in market pricing.
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