Goldman Sachs believes that a triple push from tariffs, high oil prices, and AI-related demand will keep core PCE inflation above 3% in 2026. Given the Federal Reserve’s lack of urgency to cut rates, Goldman Sachs has abandoned its expectation for rate cuts this year, pushing the final two rate cuts to June and December 2027. It also raised the probability of a rate hike from 10% to 20% and considers 'holding rates steady' a reasonable alternative.
Faced with a labor market that has significantly outperformed expectations and remarkably resilient economic data, Goldman Sachs has formally 'surrendered' to the reality of 'higher for longer.'
On June 6, according to Zhui Feng Trading Desk, in its latest research report, David Mericle, Goldman Sachs’ chief U.S. economist, completely abandoned expectations for any rate cuts this year and pushed back the timing of the final two rate cuts in its model substantially to June and December 2027.
The firm sent a clear signal in its report: under the triple catalyst of tariffs, war-driven high oil prices, and AI-related demand, core PCE inflation will remain stubbornly above 3% through 2026, leaving the Federal Reserve with no urgency to cut rates in the near term.
Moreover, Goldman Sachs doubled the probability it assigns to a Fed rate hike, raising it to 20%. This implies that markets must recalibrate their bets on a dovish policy path, and funds positioned for near-term rate cuts will face significant challenges.
Strong labor market leaves no urgency for rate cuts
Goldman Sachs noted that U.S. economic activity and labor market data have recently exceeded expectations, particularly as job growth has shown a striking rebound. According to an article from Wall Street CN, nonfarm payrolls rose by 172,000 in May—nearly double the market expectation of 88,000 and significantly higher than April’s 115,000.
Based on this, Goldman Sachs revised down its forecast for the U.S. unemployment rate this year from a previous estimate of 4.6% to just a marginal increase to 4.4%.
An unemployment rate at this level provides absolutely no 'urgency' for the Federal Reserve to lower the federal funds rate. Consequently, Goldman Sachs made a major adjustment to its baseline forecast:
It pushed back the timing of the final two rate cuts from the previously expected December 2026 and March 2027 to June and December 2027, respectively.
Although Goldman Sachs still expects GDP growth in the second half of this year to run slightly below potential due to high oil prices weighing on spending, this is insufficient to alter the Fed’s resolve to remain on hold.
Three key inflation drivers are gaining momentum, making a core PCE breach of 3% this year all but certain.
Why is the Federal Reserve迟迟 unable to pull the trigger on rate cuts?
Goldman Sachs has identified three primary inflation drivers: the pass-through effects of tariffs, elevated oil prices stemming from geopolitical conflicts, and (mis-measured and overstated) artificial intelligence (AI) demand.
Goldman Sachs expects the combined impact of these three forces to remain relatively stable throughout this year, resulting in core PCE (Personal Consumption Expenditures) inflation running above 3% for the entirety of 2026. For the FOMC, the most natural course would be to delay rate cuts until these effects dissipate and core PCE approaches its 2% target.
However, underlying fundamentals suggest that the base drivers of inflation remain subdued. Goldman Sachs estimates that current wage growth is 0.5 percentage points below the level consistent with a 2% inflation target, and leading indicators for rent growth remain very low. Therefore, barring additional supply shocks, Goldman Sachs expects inflation to revert to around 2% by 2027.
Probability of a rate hike doubles to 20%, but 'holding steady' emerges as a reasonable alternative
Although Goldman Sachs still considers it unlikely that the Federal Reserve will resume hiking rates, this tail risk is rising significantly. In its report, Goldman Sachs raised the probability of a rate hike from 10% to 20%.
Recent comments from Fed officials have clearly turned more hawkish, with several participants indicating that rate hikes remain an option if inflationary pressures worsen.
More importantly, the economy’s remarkable resilience and robust labor market data have effectively 'lowered the bar' for a rate hike—the strong economic starting point implies that even if a hike ultimately proves misguided, its associated costs and risks would be substantially smaller.
Nevertheless, Goldman Sachs also reassured markets, noting that there is currently no sign of broad-based spillover from war-induced inflationary pressures. Although the University of Michigan’s long-term inflation expectations jumped to 3.9%, Goldman Sachs’ composite indicator of persistent inflation risks remains low.
Regarding the terminal rate, Goldman Sachs maintains its forecast of 3–3.25% unchanged. This is primarily because the FOMC’s long-run dot plot has remained stable over the past year, and most committee members still view current policy as slightly restrictive, envisioning further normalization once inflation declines.
However, Goldman Sachs cautions that a prolonged pause in rate cuts would give the Federal Reserve more time to be convinced by robust economic performance that the current federal funds rate is already at an 'appropriate level.'
Moreover, the view that strong investment demand driven by AI requires higher interest rates to match could gain broader acceptance. Therefore, Goldman Sachs considers a 'flat path' of unchanged rates a highly plausible alternative scenario.
In its latest scenario-based probability forecast, Goldman Sachs provides a clear distribution:
Rate hike: Probability increased to 20% (previously 10%)
Flat path with unchanged rates: Probability at 25% (unchanged)
Base case (two rate cuts next year): Probability reduced to 30% (previously 40%)
Recession accompanied by significant rate cuts: Probability at 25% (unchanged)
Notably, even though Goldman Sachs has raised the probability of a rate hike and lowered that of rate cuts, its probability-weighted forecast for the Fed’s policy rate path remains significantly below current market pricing.
Editor/KOKO