Tighter Financial Conditions ≠ End of Rate Hikes! Goldman Sachs Predicts: Fed Pauses in October, Hikes in December

The Federal Reserve is holding its October monetary policy meeting this week. Goldman Sachs expects the central bank to hold rates steady, but notes that the rate-hiking cycle has not yet concluded.

According to Zhui Feng Trading Desk, Goldman Sachs' economics team pointed out in its preview report for the October FOMC meeting that public remarks by FOMC members following the last meeting have pointed toward a compromise solution—raising rates every other meeting. This implies that after raising rates in September, the Fed will skip the October meeting but is highly likely to act again in December, completing the second rate hike of this cycle.

Notably, the recent tightening of financial conditions is insufficient to substitute for further rate hikes. The Goldman Sachs Financial Conditions Index (FCI) has tightened by approximately 30 basis points since September, which is only slightly above the level typically associated with a 25-basis-point rate hike and far below the degree of tightening corresponding to the four rate hikes currently priced in by the market.

Goldman Sachs believes the FOMC is unlikely to view this degree of tightening as excessive or as a reason to halt further rate hikes. For investors, this means the market should not misinterpret tightening financial conditions as a signal that the rate-hiking cycle is ending prematurely.

Hold Steady in October, Expected to Hike Again in December

Remarks by FOMC members after the last meeting have clearly indicated a rhythm of "hiking every other meeting." According to the Goldman Sachs report, members stated they felt "no urgency" to raise rates further and that hikes "do not need to occur at consecutive meetings but should be implemented within a reasonable timeframe," as expressed by Federal Reserve Governor Waller.

Under this framework, having just completed a rate hike in September, the Fed is expected to skip the October meeting and implement a second rate hike in December. Goldman Sachs characterizes this December hike as the "second and final" hike of this cycle.

A key focus of the October meeting is how the FOMC will modify the statement's language regarding the September rate hike. Goldman Sachs believes the committee may adopt wording from Vice Chair Jefferson's recent speech, stating that "any further adjustments to the target range for the federal funds rate to support the timely return of inflation to the 2% goal will depend on data trends, evolving outlook, and the balance of risks." This phrasing suggests the committee prefers to accumulate more data between consecutive meetings before making decisions.

Goldman Sachs also expects that the press conference will not release significant new information. Since the plan to hike every other meeting enjoys broad support, the threshold for deviating from this plan within the year is high, and the impact of Fed communication on the market is expected to be limited. Additionally, Waller did not hint at a slowing pace during the September press conference, suggesting he may prefer to leave such signals to other committee members.

Limited Tightening in Financial Conditions, Insufficient to Replace Rate Hikes

The Fed's hawkish shift has driven interest rates significantly higher, leading to a notable tightening in the Goldman Sachs FCI since September, whereas the index had remained largely flat for most of the year prior—higher interest rates were offset by rising stock prices and narrowing credit spreads.

However, the 30-basis-point tightening in the FCI remains limited. Goldman Sachs points out that this magnitude is only slightly above the level typically associated with a single 25-basis-point rate hike and is far below the tightening corresponding to the four rate hikes currently priced in by the market, or even the substantial upward revision in market expectations for the terminal federal funds rate in 2027 since the beginning of the year.

Goldman Sachs emphasizes that this tightening stems primarily from rising interest rates, which themselves largely depend on market expectations for further rate hikes. Therefore, the FOMC is unlikely to consider the current tightening of financial conditions as excessive or as a substitute for additional rate hike actions.

Inflation Overshoot Driven by Supply Shocks; Goldman Sachs Expects No Hike in March

Goldman Sachs estimates that tariffs, energy shocks from Iran, and mismeasured components of AI-related price pressures collectively explain the entire 1.1 percentage point overshoot of core PCE inflation above the 2% target.

Goldman Sachs expects that as the impact of these three temporary factors gradually fades, the inflation trend will improve significantly by 2027. Consequently, it expects the Federal Reserve will not raise rates at its March 2027 meeting. Goldman Sachs also notes that some FOMC members may share this judgment—believing the economy is not overheating and that the inflation overshoot caused by past supply shocks can largely only wait for natural dissipation, as the employment cost of suppressing demand through tighter monetary policy would be too high. Members holding this view may tend to limit the total scale of this rate-hiking cycle.

Furthermore, if concerns arise regarding growth or employment—for example, if rising energy prices erode real income and drag down consumer spending, or if financial conditions tighten more substantially than they have now—these factors could also prompt an earlier termination of rate hikes.

Energy is the Biggest Variable

Although Goldman Sachs' baseline scenario does not include a rate hike in March, the bank explicitly acknowledges this risk.

Regarding tariffs, Goldman Sachs analysis suggests that the incremental pass-through effect of previous rounds of tariffs on consumer prices has basically ended, and year-on-year growth should continue to decline due to favorable base effects. Even if the White House replaces old tariffs overturned by courts with new ones, the impact would be relatively limited.

On the energy front, Goldman Sachs estimates that rising oil prices and widening refined product margins have already pushed up core PCE inflation by about 0.3 percentage points, and under its baseline forecast, will further push it up by 0.1 to 0.15 percentage points. However, current oil futures prices are higher than Goldman Sachs' predictions, mainly reflecting market concerns about further escalation in the Middle East. If oil prices follow the futures curve, they will additionally push up core PCE inflation by about 0.1 percentage points by March and increase overall inflation by about 0.4 percentage points. This is the clearest upside risk to Goldman Sachs' inflation forecast.

Regarding AI-related price pressures, Goldman Sachs expects their impact on year-on-year core PCE inflation to peak around the end of 2026, followed by a significant decline in 2027 as the growth rates of memory and computer prices slow down. However, since the monthly impact of memory prices on consumer prices has been relatively irregular this year, there remains some uncertainty about their impact in the coming months.

Goldman Sachs also warns that if these pressures prove more persistent, they could trigger concerns about inflation diffusion and increase the risk of companies passing on costs during the early-year price adjustment window, creating a larger "January effect" that would impact inflation data ahead of the March meeting.