Goldman now expects December Fed hike, sees chance of end to tightening

Goldman's move helped bolster the short-end Treasury rally, with two-year yields posting their largest single-day decline in over a year on Thursday, while also reducing some support for the US dollar. The main risk to this call is oil: with Brent crude back above $100 due to China's fuel export suspension and US troop deployments, a renewed energy-driven inflation surge could quickly reinstate October hike expectations. Long-term yields remain near 2002 highs, so a less hawkish Fed might do more to steepen the yield curve than to ease overall financial conditions. Friday's payrolls report is the immediate catalyst; a robust reading is likely to push hike probabilities back up regardless of Goldman's stance.

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A single soft inflation reading was enough for Goldman to move its anticipated next Fed rate increase to December and to openly question whether the Fed's tightening cycle has already concluded.

Summary:

• Goldman Sachs shifted its projection for the next quarter-point Fed rate hike from October to December
• The firm indicated a strong likelihood that the FOMC will decide further hikes are unnecessary
• August PCE inflation came in at 3.4% year-on-year versus an expected 3.7%; core PCE was around 3%
• Goldman also pointed to dovish comments from New York Fed President John Williams
• Goldman expects Q4 core PCE to be 3.0%, below the FOMC median of 3.4%
• CME FedWatch odds of a rate hike in October dipped below 40%, down from roughly 70% a week earlier

Goldman Sachs has postponed its forecast for the Federal Reserve's next interest rate increase to December from October, and stated there is a strong probability that policymakers will ultimately determine no additional hikes are required.

The bank had previously anticipated a quarter-point rise at the October meeting, which would have followed the Fed's September increase, its first since 2023. It changed its outlook after US inflation data for August arrived softer than expected and after New York Fed President John Williams delivered remarks it considered dovish.

The personal consumption expenditures price index, the Fed's preferred inflation measure, increased 3.4% from a year earlier in August, below the forecast of 3.7%. Core PCE, which strips out food and energy, rose about 0.25% month-on-month, also below expectations, resulting in an annual rate of around 3%. Goldman forecasts core PCE inflation of 3.0% on a fourth-quarter basis, lower than the 3.4% median projection from FOMC participants.

The bank also highlighted upward revisions to growth, with second-quarter GDP adjusted to 2.2% annualized and first-quarter growth to 2.5%, while reducing its third-quarter tracking estimate slightly to 3.3%. It raised concerns about Fed Chair Kevin Warsh's communication style, which favors providing markets with less information on how the central bank is likely to respond to incoming data.

Market pricing followed a similar trend. Data from CME FedWatch showed the probability of an October hike falling below 40% after the inflation report, from around 50% previously and about 70% a week earlier.

Fed officials remain divided on how much tightening is necessary. Minneapolis Fed President Neel Kashkari said on Thursday he expects further increases will be needed to restrain the economy into 2027, though he is uncertain whether the next move should occur this month. Governor Lisa Cook, speaking alongside Williams, expressed concern that supply shocks have proven surprisingly persistent and that the AI investment boom is already adding to inflation pressures.

These views appear against a backdrop of sharply elevated bond yields, with the US 10-year yield touching its highest level since 2002 on Thursday, and oil prices driven higher by the Iran war.

The next test comes with Friday's September payrolls report, which could swing the balance between an October move, a December hike, and Goldman's scenario in which the Fed holds off entirely.