Goldman warns 4.9% inflation peak in worst Iran war scenario
US equities face stagflation risks as oil shock pushes mortgage rates to 7%, S&P 500 falls 4%
Goldman Sachs economists have outlined a bleak inflation outlook under escalating conflict scenarios in the Middle East, warning that US headline PCE inflation could surge to 4.9% in the worst case, surpassing levels that triggered Federal Reserve rate hikes in 2022.
The investment bank modeled three scenarios based on the duration of disruptions in the Strait of Hormuz and potential damage to Gulf energy infrastructure. Under a severely adverse scenario involving a ten-week closure combined with infrastructure damage, Brent crude would hit $160 per barrel—exceeding the 2008 record high—pushing headline PCE inflation to 4.9% this spring.
"A 10% increase in oil prices is expected to raise headline PCE inflation by 0.2 percentage points," Goldman economists noted in their analysis, with additional pressure coming from disruptions to Gulf exports of nitrogen fertilizer, aluminum, and petrochemicals that are expected to increase PCE food prices by about 1.5% this year.
Prediction markets are already pricing elevated inflation risks. Polymarket traders assign a 97.8% probability that inflation will exceed 3% at some point in 2026, with a 46% probability that inflation tops 4%—consistent with Goldman's adverse scenario. The most likely outcome in prediction markets, at 30%, is that the Federal Reserve will maintain rates throughout 2026.
The economic shock is already rippling through US financial markets. Since the war's outset, the S&P 500, tracked by the SPDR S&P 500 ETF Trust (SPY), has declined approximately 4%, echoing 2022 when inflation surges and aggressive Fed rate hikes led to nearly a 20% decline in the benchmark index. Benchmark mortgage rates have climbed back to 7%, adding pressure on the housing market just as the spring selling season begins.
Goldman Sachs maintains its base case forecast of two 25-basis-point rate cuts in September and December, predicated on a deteriorating labor market with unemployment rising to 4.6% that would compel the Fed to act despite elevated inflation. However, the firm now assigns a 25% probability to the Fed maintaining rates throughout the year.
A scenario of persistent inflation coupled with steady Fed rates poses particular risks for investors. The combination of slowing growth and high interest rates typically compresses valuations for rate-sensitive sectors, including technology and real estate, while benefiting traditional inflation hedges like commodities and certain energy equities.
The inflation scare extends beyond US borders, with economists warning that stagflation—high inflation and stalling growth—faces the euro zone due to the energy crunch stemming from the Iran conflict. Global supply chains, already navigating post-pandemic adjustments, face renewed strain as shipping costs and commodity volatility surge.
Investors are increasingly positioning for a more volatile environment. Ray Dalio, founder of Bridgewater Associates, recently flagged "risky times" and questioned cash as a safe haven, suggesting that traditional defensive allocations may offer limited protection against the twin threats of inflation and slowing growth.