On Our "Virtual Route 99" On the Fed Courtesy Goldman Sachs

 

Why Goldman Sachs Research Expects the Fed to Remain on Hold in 2026 Ahead of this week’s Federal Open Market Committee (FOMC) meeting, markets were signaling the most uncertainty in three decades about whether policymakers would hike, according to David Mericle, chief US economist in Goldman Sachs Research. In the end, the meeting was “somewhat anticlimactic,” Mericle writes in a report. The FOMC held rates steady but issued no guidance on the future direction of rates and no details on the committee’s interpretation of the impact of inflation. “We had expected that most FOMC voters would not want to hike because the June inflation data showed substantial improvement relative to prior months,” Mericle writes. Kevin Warsh, who became chairman of the Federal Reserve in May, made several comments in his press conference after the FOMC meeting that Goldman Sachs Research interpreted as dovish, Mericle writes. Warsh appeared to downplay artificial intelligence-related price pressures and seemed to suggest that they are isolated from broader pricing trends. Asked if the rise in real, inflation-adjusted interest rates was a signal that the market thought the Fed should hike, he connected it instead to the recent strength of the economy. Warsh also hinted that the rise in market interest rates could substitute for a rate hike, though without saying so explicitly. Finally, asked if the Fed needed to raise interest rates to lower inflation, he suggested that more credibly committing to the inflation target could help to lower inflation by bringing down inflation expectations. “This contrasts with our reading of the evidence from economic research, which suggests that it is difficult for the Fed to influence inflation through the expectations channel” because most businesses and consumers are less attuned to central banks, Mericle writes.

The bond market also interpreted the FOMC meeting as dovish, Mericle writes. Near-term interest rates were lower on Wednesday, despite an increase in energy prices, while long-term interest rates rose during the meeting. The bond market is now pricing a 55% chance that the Fed hikes rates in September (as of July 29). In contrast, Goldman Sachs Research expects the Fed to keep rates steady. Mericle says he continues to expect that softer core inflation in coming months will keep the Fed on hold for the remainder of 2026. Read the full report for Mericle’s recap of this week’s FOMC meeting and its implications for future rate decisions.

Balancing the Risks to Portfolios from an Innovation Boom and Inflation Investment portfolios face two key challenges. With the boom in capital expenditure on AI, there is a growing risk that tech stock profitability slips before the benefits of the new technology start to kick in. Exposure to the equity market and tech stocks has increased in many portfolios, including the benchmark World Portfolio that often guides asset allocation. At the same time, inflation volatility and fiscal risks have risen, meaning bonds may provide less of a buffer for investors, says Christian Mueller-Glissmann, head of Asset Allocation in Goldman Sachs Research.

And while portfolio rebalancing is important, it can be costly to miss out on an ongoing rally. “When you are in these periods of incredibly strong equity returns, and when you're in these periods of tech leadership, it can be quite costly to lean against the momentum, especially if you're too early,” Mueller-Glissmann says. With those factors in mind, Goldman Sachs Research suggests five strategies for balancing portfolios: Real assets (infrastructure, prime real estate, energy, or gold) help balance multi-asset portfolios against inflation risks, provide valuable diversification, and increase the potential for real, inflation-adjusted returns. Diversifying across investment styles within equities can help manage the risks linked to tech-stock momentum. Low volatility, high-dividend-yield stocks have outperformed during declines in the technology sector. Investors may benefit from regional diversification and by managing risks linked to the US dollar and the dominance of US assets. Goldman Sachs Research finds that long-dated call options, which give investors the right to buy an asset at a certain price over a longer time period, were an effective risk-management strategy during the dotcom bubble. Alternative assets, including private markets and hedge funds, can also improve risk-adjusted returns in later phases of a boom.