Markets are trading based on a 2022-style playbook, but Goldman Sachs believes this approach may be flawed this time around. According to a research report from a team led by Kamakshya Trivedi, Goldman's head of global foreign exchange, rates, and emerging markets, concerns over surging inflation have triggered aggressive hawkish repricing. The report notes that traders are attempting to apply the inflation narrative from 2022 to current shocks, yet the bank warns that such pricing has become excessively stretched.
Compared to 2022, current fiscal stimulus is weaker and labor markets are softer, suggesting both markets and central banks may be relying on outdated assumptions. Market pricing has already exceeded reasonable upper limits. Over the past month, interest rate markets have undergone a dramatic shift—moving from widespread bets on rate cuts to pricing in hikes. In the UK, for instance, market expectations shifted from pricing in 54 basis points of cuts by the end of 2026 to 102 basis points of hikes. Similarly, in Hungary, expectations swung from 77 basis points of cuts to 118 basis points of hikes.
Even more striking, prior to signs of cooling on March 23, markets had priced in 92 basis points of hikes from the European Central Bank, 23 basis points from the Federal Reserve, 128 basis points from the Bank of Korea, and 70 basis points from the Bank of Mexico. This aggressive repricing stems not only from energy price movements but has also been fueled by unexpectedly hawkish commentary from central bankers. Fed Chair Jerome Powell hinted that moderate tightening remains appropriate, the Bank of England saw no votes for a rate cut, and some ECB officials even expressed openness to a hike in April.
Goldman Sachs clearly states that, given these extreme pricing levels, front-end rate markets appear highly asymmetric across multiple scenarios. The market’s current pricing for U.S. rate hikes and multiple ECB hikes will likely prove overly hawkish in the end.
Policymakers and markets may be overreacting, influenced by the deep imprint of the 2022 inflation crisis. The report suggests that officials are unconsciously applying a 2022 anti-inflation “war playbook” to a 2026 energy shock driven by geopolitical conflict, while ignoring fundamental differences in economic conditions. Fiscal expansion is now weaker and more targeted, broad COVID-style supply chain disruptions are absent, and post-pandemic labor markets have clearly softened. Notably, emerging market central banks—typically quick to respond to inflation shocks—such as those in Brazil, the Czech Republic, and Hungary, are now striking a more balanced tone.
This disconnect is precisely why front-end rate markets present investment opportunities—fear has outpaced reality.
Recession alarms are being overshadowed. Concerns that had previously worried markets, such as AI disruption, elevated valuations, and private credit turbulence, have been temporarily masked by war anxieties, though these issues could easily resurface. As the effects of U.S. fiscal stimulus fade in the first half of the year, economic growth is set to slow in the second half. Tighter financial conditions and the impact of high oil prices on incomes will further amplify recession pressures. Goldman’s baseline forecast shows U.S. unemployment rising noticeably this year. Worryingly, markets have been slow to react to this deep downside tail risk. Although equity volatility has increased, short-term S&P 500 put option volatility remains well below levels seen during the “growth scares” of April 2025 and August 2024. Past experience with rapid policy shifts under the Trump administration has made investors reluctant to bet on the downside or hedge aggressively.
Compared to certain convex risks in oil and growth outcomes, deep tail risks in equities and credit are significantly underestimated.
In foreign exchange and emerging markets, the U.S. dollar has reasserted its safe-haven status amid energy shocks, while most European and Asian economies face deteriorating terms of trade. If energy prices and trade flows normalize under a baseline scenario, the dollar should resume a gradual depreciation trend, and the Chinese yuan is expected to continue on a gradual but sustained appreciation path. Emerging markets have diverged sharply, with trading shifting from pro-cyclical themes to a focus on energy terms-of-trade winners and losers. If energy prices remain elevated, energy importers with limited buffers—such as India and the Philippines—will continue to underperform, while energy producers like Brazil and Colombia should demonstrate relative resilience. Should oil prices fall rapidly, pressured local currency markets such as South Africa and Hungary would experience the most pronounced volatility.
For investors, Goldman recommends maintaining a posture that can capitalize on significant market dislocations. First, asymmetry is most evident in rates markets. For those able to tolerate near-term volatility, adding long exposure to front-end rates or extending duration in portfolios are attractive strategies. Selling front-end rate put options in Europe and the UK is also feasible. Second, given that equity downside risks are underappreciated, combining selective long asset positions with long S&P 500 volatility remains an optimal approach. Even under a baseline scenario, long-term equity volatility is likely to rise over time. Investors should maintain or even increase hedges against deep downside risks in equities, credit, and cyclical currencies—these would be the market’s most vulnerable spots in the event of a sharp growth slowdown or a larger oil shock.
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