Goldman Sachs: The Middle East conflict remains an upside risk to U.S. inflation, but under the baseline scenario the shock is fading

Overview

This report tracks the potential impact of the Middle East conflict on U.S. inflation and the Federal Reserve's policy path. Goldman Sachs notes that recent renewed attacks by both the U.S. and Iran have revived market concerns about disruptions to shipping through the Strait of Hormuz and to energy supply. Even so, as of the report date, most war-driven commodity price shocks have already retreated: oil, gasoline, jet fuel, and prices of various Persian Gulf export commodities have all fallen significantly from wartime highs, and although shipping costs continue to rise, their direct effect on U.S. consumer prices is limited.

Core views

The report's core judgment is that, absent further severe escalation, the impact of conflict-related shocks on monthly U.S. inflation has already peaked or is peaking, and will gradually fade in the third and fourth quarters of 2026. Goldman Sachs expects June core PCE month-over-month at about 24bp, followed by 20-23bp in subsequent months; due to an August methodology adjustment, year-over-year core PCE could fall about 0.2 percentage points to 3.2%, and then decline only slightly further before the remaining Federal Reserve meetings in 2026. This path is sufficient to keep the Federal Reserve on hold for the rest of 2026, but the margin for error is small.

Analysis framework

The report uses two types of statistical tools to assess the transmission of the conflict to consumer prices: first, a commodity-to-consumer price pass-through model incorporating commodity price forecasts, refined product spreads, transport costs, and import spillover effects from economies affected by oil and gas shocks; second, a model based on shortage and supply chain pressure indicators to estimate the broader effects of non-energy conflict disruptions on consumer prices. The report also combines market-based and consumer inflation expectation indicators, along with Goldman Sachs' composite persistent inflation risk indicator, to assess the risk of inflation expectations becoming de-anchored.

Methodology notes

• Inflation Pass-through ModelCommodity-to-Consumer Price Pass-through Model

  How energy and commodity price shocks affect core PCE inflation

  The model incorporates commodity price forecasts, normalization of refined product spreads, the relationship between transport costs and oil prices, and import spillover effects to assess the incremental impact and timing of war and oil-price shocks on monthly core PCE inflation.

• Supply Chain Pressure ModelShortage and Supply Chain Pressure Shock Model

  The impact of non-energy conflict disruptions on consumer prices

  The model uses shortage and supply chain pressure indicators constructed by Federal Reserve System economists to estimate the path of related shocks since the war began, and evaluates their impact on consumer prices after controlling for oil price changes.

• Inflation Expectations AssessmentComposite Persistent Inflation Risk Indicator

  Whether inflation shocks could evolve into self-reinforcing high inflation

  The indicator focuses on whether firms view large price increases as normal, whether inflation expectations are rising, and whether a wage-price feedback loop has begun. The report argues that without further escalation, the war shock is not yet sufficient to trigger persistent inflation broadening.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• U.S. Rates

  The conflict affects the inflation path, which in turn affects expectations for Federal Reserve policy.

  Strengths

  The baseline inflation path is sufficient to support the Federal Reserve staying on hold for the rest of 2026.

  Weaknesses

  Year-over-year inflation will still decline only slowly, leaving limited policy margin for error.

  Comparison

  If the conflict does not escalate, policy pressure is lower than in the risk scenario where oil returns to $100 per barrel.

  Risks

  Higher oil prices, prolonged supply shocks, or de-anchored inflation expectations could raise the probability of rate hikes.

• Crude Oil and Refined Products

  Energy prices are the core channel through which this conflict transmits to inflation.

  Strengths

  As of the report date, oil, gasoline, and jet fuel prices have all fallen significantly from wartime highs.

  Weaknesses

  Although Gulf oil flows remain above their lows, geopolitical conflict can rapidly alter supply expectations.

  Comparison

  The current price shock is clearly below wartime highs and the 2021-22 supply chain shock environment.

  Risks

  If oil returns to $100 per barrel, it will directly lift core inflation over the coming months.

• U.S. Inflation-linked Assets

  Inflation expectations and the actual inflation path determine TIPS, inflation swaps, and related risk premia.

  Strengths

  Market-based inflation compensation indicators remain relatively moderate, and overall expectations do not show clear de-anchoring.

  Weaknesses

  Some consumer inflation expectation indicators are elevated, although their reliability is questioned.

  Comparison

  Market-based indicators are more moderate than consumer survey measures and are also watched more closely by Federal Reserve officials.

  Risks

  Persistent supply shocks could make firm pricing, wage feedback, and expectation mechanisms self-reinforcing.

• Airlines and Consumer Service Prices

  Falling jet fuel prices may push down airfares and related prices in the coming months.

  Strengths

  Jet fuel prices have fallen 35% from the peak, easing airfare inflation.

  Weaknesses

  Transport network efficiency, fuel surcharges, and peak-season freight demand may still push up some costs.

  Comparison

  Current shipping cost pressure is far lower than in 2021-22.

  Risks

  If energy prices rise again, airline and transport-related prices may come under pressure once more.

Key data

• Oil prices relative to wartime peakabout 30% lowerOil prices rose only modestly during the latest escalation and remain significantly below late-April and early-May levels.
• Retail gasoline pricesdown 15%The report argues this should help lower headline CPI in June.
• Jet fuel pricesdown 35%Expected to put downward pressure on airfares in the coming months.
• International transport costs as a share of U.S. consumer goods import costs1-2%Therefore, the current rise in transport costs is expected to have a limited impact on consumer prices.
• June core PCE month-over-month forecast24bpGoldman Sachs expects core PCE month-over-month to remain in the 20-23bp range in the following months.
• August core PCE year-over-year forecast3.2%The methodology adjustment is expected to lower the year-over-year rate by about 0.2 percentage points.
• Scenario of oil returning to $100 per barrelmonthly core inflation rises an additional 3-4bpThis scenario could also amplify the impact on monetary policy discussions through concerns about inflation expectations.

Impact & implications

For investors, the report implies that under the baseline scenario, upside pressure on U.S. inflation is easing at the margin, supporting unchanged Federal Reserve rates for the rest of 2026; however, energy prices remain the key tail risk. If the Middle East conflict escalates materially again and pushes oil prices higher, the direct inflation pass-through may not be enormous, but combined with fatigue from prolonged supply shocks and worries about de-anchored inflation expectations, it could shift the focus of FOMC discussions and raise the probability of rate hikes.

Risks

• Further escalation of the U.S.-Iran conflict, threatening shipping through the Strait of Hormuz and pushing oil prices higher.
• Oil returning to $100 per barrel and staying there through year-end, causing monthly core inflation to rise an additional 3-4bp in the coming months.
• Successive supply shocks undermining public and business confidence in declining inflation, increasing the risk of de-anchored inflation expectations.
• Limited decline in year-over-year core PCE, leaving the Federal Reserve with little policy margin for error at the remaining 2026 meetings.
• Elevated consumer inflation expectation survey signals, potentially triggering differences within the FOMC over inflation risks.

What to watch

• Whether the Middle East conflict escalates again and whether shipping through the Strait of Hormuz faces material disruption.
• Whether Brent or WTI oil prices approach or return to $100 per barrel.
• June and subsequent CPI and PCE data, especially whether core PCE month-over-month remains in the 20-23bp range.
• The actual extent of the downward revision to year-over-year core PCE from the August BEA inflation methodology adjustment.
• Changes in market-based inflation compensation indicators, University of Michigan consumer inflation expectations, and the Federal Reserve's composite inflation expectation indicators.
• Whether shortage indices, supply chain pressure indicators, shipping costs, and Persian Gulf export commodity prices continue to decline.