The Iranian war shock is impacting global asset pricing. Goldman Sachs believes the market has priced in monetary policy tightening significantly excessively, and for the stock market to bottom out and rebound, it does not need to wait for the crisis to be fully resolved, but merely for the market to see the boundaries of downside risks.
Dominic Wilson, Chief Cross-Asset Strategist at Goldman Sachs, pointed out in a recent report that since the outbreak of the conflict in Iran, the market has primarily characterized this shock as a large-scale &#34;hawkish policy shock&#34; rather than a growth shock, causing interest rate pricing in major economies to shift significantly higher. This pricing is a clear misjudgment in magnitude, and the downside risk for policy rate pricing is notably asymmetric.
Meanwhile, historical experience suggests that stock market recoveries often do not require waiting for the crisis to be fully resolved, but merely for the market to confirm that downside risks have reached their limit. Using the COVID-19 pandemic and tariff shocks as examples, stock markets bottomed out before the real economy's pressures peaked. While current market pricing is more pessimistic than the base case scenario, it may still not fully reflect the probability of a U.S. recession or more adverse oil price scenarios.
At the cross-asset allocation level, once downside tail risks narrow, U.S. and European equities, U.S. Treasuries, and European currencies are expected to benefit the most. In more adverse scenarios, European assets, the Japanese yen, and low-yield positions offer relatively better hedging value.
<h2>Market Direction Mostly Correct, but &#34;Hawkish Magnitude&#34; Exceeds Fundamentals</h2>
The market volatility triggered by the Iranian war is largely in line with macroeconomic fundamentals in terms of direction – risk premiums rising, cyclical assets weakening, energy consumers under pressure, and inflation and interest rate pricing moving higher. However, there are two significant deviations between the market's reaction and fundamental forecasts in terms of magnitude and structure.
First, and most significantly, the magnitude of monetary policy tightening priced in by the market far exceeds reasonable levels indicated by historical experience. Historically, the impact of oil supply shocks on interest rates is ambiguous – growth drag and inflationary pressures offset each other. However, the market has rapidly priced in rate hikes for multiple major economies, leading to substantial increases in front-end rates. A decomposition model of growth and policy shocks shows that this crisis has so far primarily manifested as a large-scale hawkish policy shock, with a relatively moderate growth shock.
The second deviation is that assets that performed well before the war have generally fallen more than fundamental forecasts predict, indicating that position unwinding has created an additional amplification effect on the market, affecting interest rate markets, some non-U.S. equities, currencies, and gold.
<h2>Overpricing of Rate Hikes, Interest Rates Have Downside &#34;Asymmetry&#34;</h2>
Current market pricing of policy rate distributions is misguided, with downside risks being significantly asymmetric. The market has now priced in rate hike expectations for almost all major economies, with the implied break-even points for front-end out-of-the-money put options in the U.S., Eurozone, and UK corresponding to multiple rate hikes this year. Weighted average policy rate forecasts are lower than forward pricing, with particularly significant gaps in the U.S. and Europe.
Historical experience shows that following oil supply shocks, policy rates rise slightly on average within 1 to 3 months, but fall within 6 to 9 months as growth concerns mount. During the 1990 oil shock, the market also heavily priced in hawkish policy risks, but the Federal Reserve ultimately cut rates significantly. Inflation concerns this time may prove excessive in the face of downside growth risks and rising unemployment pressures, especially in the U.S., but the same applies to the European Central Bank.
Until oil prices themselves stabilize, yields may continue to face upward pressure, and the market may struggle to escape this dynamic in the short term.
<h2>Growth Pricing Below Baseline, But Fails to Reflect Tail Risks</h2>
In terms of growth pricing, Goldman Sachs believes the market's current implied pricing for U.S. growth over the next 12 months is around 1.3%, lower than its own baseline forecast, but may not fully reflect more adverse oil price scenarios.
Growth pricing remains fragile. If the defined more adverse oil price scenario materializes, the market has not fully priced in this tail risk. Furthermore, the tightening of global financial conditions itself – driven by rising interest rates – is sufficient to support a meaningful downward revision in growth. If this trend continues or intensifies, the actual growth shock could exceed current assumptions.
While current pricing is already significantly pessimistic, it may not fully reflect a 30% probability of a U.S. recession or the risks embedded in more adverse oil price scenarios.
<h2>Stock Market Rebound Doesn't Need &#34;Problem Solving,&#34; Just &#34;Shock Peaking&#34;</h2>
In crisis scenarios, the most intense market rebounds often stem from the narrowing of downside tail risks, rather than the complete resolution of the crisis. Drawing from the experiences of the COVID-19 pandemic and tariff shocks, stock markets often bottom out before the worst of the real economy arrives – stock markets are far more forward-looking than physical markets.
At a price-to-earnings ratio of 25 times, even if the S&amp;P 500's earnings for an entire year were completely wiped out, the discount to the market would only be about 4% under unchanged risk premiums. This implies that even with substantial economic damage ahead, stock markets often only need to see the boundary of the shock to form a bottom – a &#34;vague resolution path&#34; can also trigger a rebound.
The most direct trigger path lies in some degree of de-escalation of the conflict, even if supply disruption risks persist. In most scenarios, oil prices will structurally remain above pre-war levels, and the terms of trade shock will only be partially reversed.
<h2>Cross-Asset Allocation: Three Axes Determine Benefiting Assets</h2>
The cross-asset allocation framework is primarily centered around three axes: assets benefiting from the narrowing of cyclical tail risks, assets benefiting from improved terms of trade, and assets benefiting from policy easing.
In a de-escalation scenario, interest rates and equities are expected to rebound in tandem, volatility to decline sharply, and the dollar to weaken. Relative to implied volatility, long positions in U.S. and European equities, credit, European currencies (including CEE-3 currencies), and U.S. Treasuries offer the highest risk-reward. Additionally, South Korean and Japanese equities, and some cyclical sectors in the U.S. due to unusually large declines, are worth watching for their rebound potential. If clear signals of policy easing emerge, sectors sensitive to interest rates like homebuilders may also outperform, and gold could see upside.
In the medium term, there is a preference for terms-of-trade beneficiaries, including UK, Australian, and Brazilian equities, the Brazilian Real, Australian Dollar, Mexican Peso, as well as copper and gold.
In more adverse scenarios, European assets (equities, foreign exchange, and credit) continue to offer relative hedging value in most downside scenarios. If the market shifts to broader recession concerns, the Japanese yen will strengthen, low-yield positions will become more attractive, and the Australian Dollar, Canadian Dollar, and some high-yield emerging market currencies will serve as hedges against the U.S. dollar and yen. Copper will also face greater downside pressure.
<h2>Cross-Scenario Consensus: Bonds Have a &#34;Smiling Curve,&#34; Long-Term Equity Volatility is Low</h2>
Across all scenario paths, two judgments have relatively broad applicability, independent of specific crisis resolution methods.
First, interest rates exhibit a &#34;smiling curve&#34; structure. Both in a de-pricing of hawkish expectations scenario under de-escalation or a growth panic-driven scenario in a deeper recession, bonds – especially short-end G10 rates – and the Japanese yen are expected to benefit. This structure implies that bond yields may decline under various outcomes.
Second, long-term equity volatility and credit spreads are likely to structurally shift higher. In most projected paths, including the baseline scenario, long-term equity volatility will continue to rise, and credit spreads will widen.
For tail hedging, European assets perform relatively well in both upside and downside scenarios. In deeper downside scenarios, a strategy of shorting cyclical currencies (like the Australian and Canadian dollars) against the U.S. dollar and yen will also become more attractive.

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Goldman Sachs warns that the market has misinterpreted the current crisis as a "hawkish policy shock," leading to interest rate hike pricing that exceeds fundamentals. The downside risk for interest rates is highly asymmetric. Historically, following oil supply shocks, policy rates have risen slightly on average within 1 to 3 months, but then retreated within 6 to 9 months as growth concerns intensified. More critically, a stock market bottom does not require the crisis to be resolved; a rebound can occur as long as the market perceives the "limit of the shock" is reached, preceding the real economy's recovery

- The article discusses the impact of the Iran conflict on global asset pricing, with Goldman Sachs estimating that market pricing of interest rate hikes has significantly overreacted.  
- It highlights historical parallels where stock markets recovered without waiting for crises to resolve, suggesting current pessimism might not accurately reflect recession probabilities or adverse oil scenarios.  
- The report emphasizes potential benefits for assets like US and European stocks and suggests strategies for cross-asset allocations depending on different economic scenarios.

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Goldman Sachs: Interest Rate Market Too "Hawkish," Stock Rebound Needs No "Problem Solving," Just "Shock Reaching Limit"