Markets and Central Banks Turn Hawkish: Goldman Explores How to Hedge?

Energy price shocks combined with a hawkish pivot by central banks are reshaping the logic of global asset pricing, presenting investors with unprecedented hedging challenges. Goldman Sachs strategists Dominic Wilson and Kamakshya Trivedi warned in their latest report that market and central bank hawkish repricing has already significantly overshot, with notable asymmetry in rate pricing, and front-end yields offering attractive long opportunities across various scenarios. Concurrently, as Federal Reserve officials release vague signals that rates can go up or down, market expectations for the end of the rate-cutting cycle continue to rise, further compressing the upside potential for risk assets. From an asset price perspective, the interest rate market has been the most volatile area during this shock, while equities and credit markets have overall remained resilient, not yet fully pricing in deep downside tail risks. Goldman Sachs believes that with the scenario distribution being extremely broad, investors' primary task is to build hedges selectively while maintaining flexible positioning. Hawkish Repricing Has Significantly Overshot The Goldman Sachs report points out that since the surge in energy prices, hawkish repricing at the front end of the yield curve has been the most prominent feature of all market movements. In the UK, for example, market pricing shifted abruptly from previously anticipating 54 basis points of rate cuts within the year to anticipating 102 basis points of hikes; Hungary shifted from expecting 77 basis points of cuts to expecting 118 basis points of hikes. Before signs of easing emerged on the 23rd, markets had priced in 92 basis points of hikes for the European Central Bank, 23 basis points for the Federal Reserve, 128 basis points for South Korea, and 70 basis points for Mexico. Driving this aggressive repricing were not only energy prices themselves but also unusually hawkish statements from central banks. Fed Chair Powell explicitly stated that a moderately restrictive policy remains appropriate; the Bank of England's Monetary Policy Committee had no votes in favor of a rate cut; and several ECB officials publicly stated that a rate hike could be discussed at the April meeting. According to The Wall Street Journal, signals from within the Federal Reserve have seen a subtle but significant shift. Chicago Fed President Austan Goolsbee became one of the first officials to explicitly mention the possibility of rate hikes, stating, "I can envision a scenario where we need to raise rates if inflation performs poorly." Governor Christopher Waller, previously considered a dove, also stated that the inflationary risks from the Iran conflict prompted him to support keeping rates unchanged in March. San Francisco Fed President Mary Daly warned of the risk that the dot plot could convey "false certainty," and that there is no single most likely path for interest rates. Central Banks May Be "Fighting the Last War" Despite the strong momentum of hawkish repricing, the two Goldman Sachs strategists emphasized that this repricing has clearly exceeded the reasonable range in most benchmark scenarios, and they presented a core judgment: this aggressive repricing partly stems from the "psychological trauma" left by the underestimation of the 2022 inflation shock. The G10 central bank officials' high attention to indirect effects, second-round effects, and the risk of inflation expectations de-anchoring is also similar to that period. Several important differences exist between this round and 2022: fiscal impulse is clearly weaker than then, and any fiscal support is more targeted; widespread supply chain disruptions from the COVID-19 pandemic have not recurred; and the labor market is significantly weaker than in the post-pandemic period. Notably, emerging market central banks – usually more sensitive to inflationary shocks – have adopted a more balanced stance, as seen in Brazil, the Czech Republic, and Hungary. This phenomenon is viewed as one "signal" of current excessive hawkish pricing. Meanwhile, according to Bloomberg, Ian Lyngen, head of U.S. rate strategy at BMO Capital Markets, also pointed out that the front end of the Treasury yield curve no longer views energy prices as an inflation risk to follow, but rather focuses on economic growth and downside risks for risk assets. Recently, while oil prices continued to rise and US stocks were sold off, US Treasury yields did not climb as usual but instead fell significantly, completing a clear logical decoupling. In response to this anomaly, some analysis suggests the market is paying more attention to the deterioration of economic fundamentals. From a fundamental perspective, the pricing of Fed rate hike risks and expectations of multiple European rate hikes are overly hawkish, with front-end rates offering clear asymmetric long opportunities. Front-End Rates: The Most Prominent Asymmetric Opportunity The asymmetry in the interest rate market is the clearest area of change since this shock, and for investors who can tolerate short-term volatility, increasing front-end longs or lengthening duration in their portfolios is highly attractive. Specifically, one could sell put options on European and UK front-end rates, with breakeven points corresponding to multiple rate hikes; for hedging against deeper rate declines (or associated USD/JPY declines) and joint scenarios of rates and stocks falling simultaneously, these are also worth including in a medium-term risk management framework. Historical experience from the 1990s shows that even if rate hikes are ultimately proven excessive, yields are unlikely to rebound significantly before energy prices clearly fall – although the peak in yields may occur earlier than the peak in oil prices. This pattern further strengthens the logic of building long positions at the front end today. US Equities and Credit: Downside Tail Still Underestimated Compared to the sharp adjustments in the interest rate market, US equities and credit markets have so far priced in significantly insufficient downside tail risks. Short-term S&P 500 put option implied volatility remains well below the levels seen during the tariff shock in April 2025 and the growth scare in August 2024. The experience of a rapid policy reversal after the tariff shock has made investors more resistant to downside hedges, but the current resolution path is clearly more complex. Considering the convexity of oil price movements and the uncertainty of growth outcomes, downside tail risks in US equities and credit remain underestimated. The report suggests that under the current baseline scenario, maintaining or even increasing downside protection positions in equities, credit, and cyclical foreign exchange remains reasonable, and the long-term upside for equity implied volatility continues to be favored. For option hedges, while the prices of call options on US and European equities (and European FX) are expensive, they are not extreme compared to historical periods of sharp declines; if upside potential is suppressed by pre-existing concerns (AI disruption, high valuations, private credit turmoil), call spread strategies also offer rationality. Broad Scenario Distribution, Highly Uncertain Path Ahead The core challenge facing the market today lies in the exceptionally broad scenario distribution, where minor shifts in perceived tail risks can trigger violent two-way fluctuations in asset prices. In an optimistic scenario, a rapid de-escalation of the situation would first drive a rebound in the most heavily pressured assets, including European and cyclical assets, non-US currencies, and front-end rates, with South Korean stocks and Hungarian forints potentially leading the recovery. In a pessimistic scenario, if oil prices surge further and trigger clear recession fears, it would cause a more widespread shock to risk assets, with previously resilient assets like copper, the Brazilian real, and the Australian dollar also affected. In such a case, G10 safe-haven currencies like the Japanese yen and Swiss franc are expected to strengthen, and the yield curve's center of gravity would systematically shift lower. Between these extremes, in an intermediate path, the market might see partial recovery, but the divergence in energy trade conditions will be more distinctly reflected between foreign exchange and equities, with assets from energy-exporting countries (e.g., Brazilian stocks, Australian dollar) continuing to benefit relatively. Furthermore, pre-war concerns in the market – AI disruption expectations, high valuations, private credit volatility – have not dissipated. Once geopolitical tensions marginally ease, these issues could quickly re-enter market focus, posing the main suppressing force for any rally.