Goldman Sachs has postponed its projected timing for the Federal Reserve's next two interest rate cuts by one quarter each, citing the impact of Middle East conflicts driving up energy costs and persistently high inflation. This has further cooled market expectations for monetary policy easing.
In a report dated May 8, Goldman Sachs economists shifted their forecast for the Fed's next two rate cuts to December 2026 and March 2027, each a quarter later than previously anticipated. The bank argues that the pass-through effect of higher energy costs will keep core PCE inflation near 3% throughout the year, well above the Fed's 2% target, making conditions for rate cuts difficult to materialize.
The Federal Reserve held interest rates steady late last month, but meeting minutes revealed that uncertainty stemming from Middle East conflicts disrupting global energy markets is deepening divisions within the Federal Open Market Committee (FOMC) over the policy outlook. Goldman Sachs' latest forecast reinforces market concerns about a delayed rate-cut timetable.
The bar for rate cuts has been raised, requiring simultaneous softening in the labor market. Goldman Sachs economists noted that for the FOMC to initiate rate cuts this year, two conditions must be met simultaneously: a clear decline in monthly inflation data after the oil price shock subsides, and further softening in the labor market. Both are deemed necessary.
This implies that improvement in inflation data alone is insufficient to trigger rate cuts; cooling in the job market is also a prerequisite for Fed action, setting a notably higher threshold for a policy pivot than previously anticipated by the market.
Terminal rate forecast remains unchanged, with most officials still expecting room for future cuts. Despite the delayed timing for rate cuts, Goldman Sachs maintains its forecast for the Fed's terminal rate at 3% to 3.25%, citing overall stability in FOMC members' assessment of the neutral rate. The economists pointed out that most officials still anticipate at least several more rate cuts eventually.
This view suggests that Goldman Sachs does not believe the current rate-cutting cycle has ended, only that its pace is slower than previously expected.
Regarding economic prospects, Goldman Sachs lowered the probability of a U.S. economic recession within the next 12 months by 5 percentage points to 25%. However, the bank noted that this figure remains above the pre-Iran conflict baseline estimate of 20%, indicating that downside risks to the U.S. economy from Middle East tensions have not fully dissipated.
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