So, oil prices are up. Way up. And when oil prices spike, everyone starts looking nervously at the Federal Reserve. Will they hike rates to fight the inflation? Markets seem to think there's a decent chance. Since the conflict in the Middle East began, the probability traders are assigning to a Fed rate hike in 2026 has jumped from a sleepy 12% to a much more alert 45%, according to the CME FedWatch tool.

Goldman Sachs looked at that number, blinked, and basically said, "Nah." In a note published Wednesday, the bank's economist Manuel Abecasis laid out a pretty compelling case for why the Fed is almost certainly not going to flinch. He argues that rate hikes remain a tail risk—a remote possibility—not a base case, even with oil staying high. Here’s the breakdown of why Goldman thinks the market is getting a bit too excited.

The Oil Shock Isn't as Big as You Think

First, let's talk about the scale of the problem. Goldman argues the current supply disruption from the Strait of Hormuz is narrower and less severe than the epic energy crises of the 1970s or the global supply-chain mess of 2021–2022. Even in their own worst-case scenario for oil prices, the shock is smaller in size and shorter in duration than those historical nightmares.

Plus, the U.S. economy just doesn't guzzle oil like it used to. We're far less dependent on it today than we were fifty years ago, which means an oil price spike doesn't translate into runaway inflation as easily as it once did.

"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," Abecasis said. "In addition, the economy is much less dependent on oil today than it was in the 1970s."

No Wage Spiral Means No Fire to Fight

Reason number two: the labor market is cool. Not cold, but definitely not overheating. This is a crucial difference. In both the 1970s and 2021–2022, oil shocks crashed into labor markets that were already red-hot. Wage growth was soaring, government spending was pumping money into the economy, and people were starting to expect high inflation forever.

None of that is true today. Wage growth is already below the pace that would be consistent with the Fed's 2% inflation target, and inflation expectations are firmly anchored. Goldman's own dashboard for persistent inflation risk is sitting at the 35th historical percentile—closer to the calm of the 1990s and 2000s than to any crisis period.

"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 Doing the Work

Third, monetary policy isn't starting from zero. The federal funds rate is already 50 to 75 basis points above what the Fed itself considers a "neutral" rate—the level that neither stimulates nor slows the economy. That means policy is already in restrictive territory.

And since the conflict began, financial conditions have tightened by about 80 basis points all on their own. The market is, in a way, doing some of the Fed's potential tightening work for it before the committee even meets. Back in early 2022, rates were at zero. In the 1970s, they were well below neutral. Today, the setup is the complete opposite.

The Fed Doesn't Hike Because of Oil

Finally, and this might be the most historical argument: the Fed simply doesn't tighten monetary policy just because oil prices go up. Goldman's analysis of Fed speeches found no meaningful statistical link between mentions of oil price shocks and officials using tougher, more hawkish language about policy. The European Central Bank? Different story. They have a much stronger reaction to energy prices.

Even the Fed's own internal simulations of higher oil price scenarios consistently show no change to the projected policy path. "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 note stated.

So, what's Goldman's actual forecast? Their baseline hasn't changed: they still expect two rate cuts in 2026, one in September and another in December, bringing the terminal rate down to 3.0%–3.25%. They also assign a 30% probability to a recession. And in that recession scenario, they expect the Fed to cut rates substantially, not hike them.

"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," Abecasis concluded.

What This Means for Your Portfolio

If Goldman's right, then the bond market has probably overreacted. Yields on short-duration Treasuries have shot up on these hike fears that may never come to pass. That means they could snap back down just as quickly if oil prices stabilize or if the Fed signals it's going to stay patient. For bond investors willing to bet against the panic, that's a potential entry point.

The most direct ways to make that trade are through ETFs like the iShares 20+ Year Treasury Bond ETF (TLT) and the iShares 7-10 Year Treasury Bond ETF (IEF).

For stock investors, the math is similar. The nightmare scenario that's spooking the market—a stagflation trap where the Fed hikes rates into a slowing economy—is the exact scenario Goldman gives the lowest probability of happening.

That doesn't mean it's impossible. But it does suggest stocks might be pricing in a policy mistake that the Fed has very little historical interest in making. The SPDR S&P 500 ETF Trust (SPY) is down about 6% since the conflict began. If the Fed holds steady as Goldman expects, that selloff might look like an overreaction to a risk that never showed up.

The trickier question, of course, isn't about the Fed's reaction. It's about the oil shock itself. Regardless of what the central bank does, higher energy costs could still pinch corporate earnings and shape where the market goes from here.