The Iran war has lit a fire under oil prices — and under Fed hike bets. 

Since Operation Epic Fury began in late February, markets have swung dramatically, now pricing a roughly 45% probability that the Federal Reserve raises rates in 2026 — up from just 12% before the war, as per CME FedWatch.

Goldman Sachs says that’s too hawkish by a wide margin. The Fed almost certainly won’t flinch.

In a note published on Wednesday,  the bank’s economist Manuel Abecasis laid out four reasons why rate hikes remain a tail risk — not a base case — even as oil prices remain high.

The Hormuz Oil Shock Is Smaller Than Markets Fear

The first argument is the scale of the shock.

Goldman argues the current supply disruption is narrower and less severe than the 1970s energy crisis or the 2021–2022 global supply-chain collapse.

Even under the bank’s most adverse scenario, the shock falls short of those episodes in both size and duration.

The U.S. economy today is far less oil-dependent than it was fifty years ago, meaning the inflationary passthrough is structurally weaker.

“Even our oil strategists’ severely adverse oil price scenario would amount to a smaller shock than the 1970s and a less prolonged shock than in 2021-2022. In addition, the economy is much less dependent on oil today than it was in the 1970s,” Abecasis said.

No Wage Spiral, No Kindling

Second: the labor market is not overheating.

In both the 1970s and 2021–2022, oil shocks hit an already overheating labor market — wage growth was running hot, fiscal policy was expansionary, and inflation expectations were becoming unanchored.

None of those conditions exist today. Goldman’s persistent inflation risk dashboard currently sits at the 35th historical percentile — closer to the benign 1990s–2000s than to either prior crisis.

“The labor market is softening, wage growth is already below the pace that would be consistent with 2% inflation, and inflation expectations are well anchored,” Abecasis added.

Interest Rates Are Already Restrictive

Third: monetary policy is already in restrictive territory.

The fed funds rate sits 50–75 basis points above the FOMC’s own median neutral rate estimate. 

Financial conditions have tightened by roughly 80 basis points since the conflict began — doing some of the Fed’s work before any vote is even cast.

In early 2022, the funds rate was at zero. In the 1970s, it was well below neutral. The setup is the inverse today.

The Fed Has Never Hiked On Oil Alone

Fourth: the Fed doesn’t tighten in response to supply-side oil shocks.

History backs Goldman’s skepticism. Analysis of Fed speeches finds no meaningful statistical relationship between oil price shocks and tighter monetary language from FOMC officials — unlike the ECB, which has a much stronger hawkish reaction function to energy prices.

Fed staff simulations of higher oil scenarios consistently project no change to the policy rate versus the baseline.

“We find no meaningful relationship between mentions of oil price shocks and tighter monetary policy in speeches by Fed officials — but a much stronger relationship in speeches by ECB officials.”

The bank’s baseline remains two cuts in 2026 — in September and December — with a terminal rate of 3.0%–3.25%. It assigns a 30% probability of a recession, in which case it expects the FOMC to cut substantially rather than hike. 

“Both because we continue to expect two cuts in our baseline forecast and because we see hikes as less likely than the market implies, our probability-weighted Fed forecast remains meaningfully more dovish than market pricing.”

Why This Matters For Investors

If Goldman is right, the bond market has overshot.

Yields on short-duration Treasuries have surged on hike fears that are unlikely to materialize — which means they could snap back sharply the moment oil stabilizes or the FOMC signals patience. That’s a potential entry point for bond investors willing to fade the panic.

The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) and the iShares 7-10 Year Treasury Bond ETF (NASDAQ:IEF) are the most direct vehicles to express that trade.

For equity investors, the calculus is similar.

The scenario that worries markets most — a stagflation trap where the Fed hikes into a slowing economy — is precisely the scenario Goldman assigns the lowest probability.

That doesn’t mean it can’t happen. But it does mean equities may be pricing in a policy mistake the Fed itself has little historical appetite for making.

The SPDR S&P 500 ETF Trust (NYSE:SPY) has dropped roughly 6% since the start of the Iran war. If the Fed holds — Goldman’s base case — that selloff may prove to be an overreaction to a hike risk that never arrives.

 The harder question is whether the oil shock itself, not Fed policy, is what ultimately determines where earnings land from here.

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