In the face of a far stronger-than-expected labor market and remarkably resilient economic data, Goldman Sachs has formally capitulated to the reality of 'higher for longer' interest rates.
On June 6th, the investment bank's chief US economist, David Mericle, completely abandoned expectations for rate cuts this year in a new research report. He also pushed back the timing of the final two projected cuts in the bank's model significantly, to June 2027 and December 2027.
The report sent a clear signal: driven by a triple catalyst of tariffs, war-induced high oil prices, and AI-related demand, core PCE inflation is expected to remain stubbornly above 3% through 2026, eliminating any sense of urgency for the Federal Reserve to cut rates in the near term.
Furthermore, Goldman Sachs doubled its probability for a Fed rate hike to 20%. This implies that markets must recalibrate their bets on an easing path, and funds positioned for imminent cuts will face a stern test.
Robust Labor Market Erodes Case for Cuts
Goldman noted that US economic activity and labor market data have been stronger than anticipated in recent months, with a particularly notable rebound in employment growth. The US added 172,000 non-farm payrolls in May, nearly double the market consensus of 88,000 and well above April's figure of 115,000.
Consequently, Goldman revised its forecast for the US unemployment rate this year, lowering it to a slight increase to 4.4% from a prior estimate of 4.6%.
This level of unemployment simply does not create any "urgency" for the Fed to lower the federal funds rate. As a result, Goldman made a significant adjustment to its baseline forecast, pushing the final two rate cuts from December 2026 and March 2027 back to June 2027 and December 2027.
Although Goldman still expects GDP growth in the second half of the year to be slightly below its potential level, dragged by high oil prices impacting spending, this is insufficient to alter the Fed's determination to hold policy steady.
Three Inflationary Forces Set to Keep Core PCE Above 3%
Why is the Fed unable to pull the trigger on rate cuts? Goldman points to three primary inflationary drivers: the pass-through effects of tariffs, war-related high oil prices, and (mis-measured and overestimated) AI demand.
Goldman expects the combined impact of these forces to remain relatively stable this year, which will keep the year-on-year core PCE inflation rate above 3% throughout 2026. For the FOMC, the most natural path is to delay rate cuts until these effects subside and core PCE moves closer to the 2% target.
However, from a fundamental perspective, the underlying drivers of inflation remain soft. Goldman calculates that current wage growth is 0.5 percentage points below the level consistent with 2% inflation, and leading indicators for rent growth remain very low. Therefore, barring additional supply shocks, Goldman expects inflation to fall back near 2% by 2027.
Doubled Hike Probability, But 'On Hold' Remains a Plausible Path
While Goldman still views a Fed return to rate hikes as unlikely, this tail risk is rising notably. The bank raised its probability for a hike from a prior 10% to 20% in its report.
Recent commentary from Fed officials has clearly turned more hawkish, with several participants indicating that rate hikes are possible if the inflation situation deteriorates.
More importantly, the resilient economy and jobs data have effectively "lowered the bar for hiking"—a strong starting point means the cost and risk of a hike, even if it proves to be a mistake, would be much smaller.
Nevertheless, Goldman sought to calm markets, noting that there are no signs yet of a broad spread of war-induced inflation shocks, and while the University of Michigan's long-term inflation expectations jumped to 3.9%, Goldman's composite indicator of persistent inflation risk remains low.
On the terminal rate, Goldman maintained its forecast of 3-3.25%. This is primarily because the FOMC's longer-run dot plot has remained stable over the past year, and most members still view current policy as slightly restrictive and envision further normalization once inflation declines.
However, Goldman warned that a longer pause on cuts gives the Fed more time to be convinced by solid economic performance that the current federal funds rate is already at an "appropriate" level.
Additionally, the view that strong AI-driven investment demand requires higher rates to match may gain more traction. Therefore, Goldman sees a "flat path" of unchanged rates as a very plausible alternative scenario.
In its latest probability-weighted forecast, Goldman provided a clear distribution: a rate hike at 20% probability (up from 10%); a flat path of unchanged rates at 25% (unchanged); the baseline scenario of two cuts next year at 30% (down from 40%); and a recession with significant cuts at 25% (unchanged).
It is noteworthy that even after raising the hike probability and lowering the cut probability, Goldman's probability-weighted path for the Fed's policy rate remains significantly lower than the current market pricing.
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