Global macro tug-of-war between escalating conflict and falling inflation

Overview

This report focuses on the renewed escalation of Middle East conflict, the rebound in energy prices, improving US inflation, policy paths of major central banks, and slowing growth in China. Goldman Sachs' core view is that oil price risks are skewed upward in the short term, but underlying inflation signals in the US and other developed economies are improving; the US economy remained close to trend growth in the first half, but may weaken in the second half as consumer cash flow slows; and there are differences between major central bank policy paths and market pricing.

Core views

First, risks to the oil price forecast are skewed to the upside on net, but if the conflict eases, Gulf export recovery capacity could cause oil prices to fall back quickly. Second, the US labor market is slightly cooler than normal, with estimated underlying job growth falling from 130k a month ago to 73k, while wage trackers have slowed to 3.4%. Third, US core PCE remains elevated, but part of this reflects measurement issues, software and accessories prices, energy pass-through, and tariff pass-through, and it is expected to approach 2% in 2027. Fourth, the possibility of a rate hike at the Fed's July 28-29 meeting has essentially disappeared, and any future hikes would require either higher inflation or lower unemployment. Fifth, Goldman Sachs is more dovish than the market on the policy paths of the ECB and especially the BoE. Sixth, China's growth structure is diverging, with exports and industrial production relatively strong, but imports, property, and consumption weak.

Analysis framework

The report uses a top-down global macro framework that links the impact of geopolitical conflict on energy prices, US growth and the labor market, core inflation measurement, central bank reaction functions, China's growth structure, and cross-asset strategy recommendations to form a view on major asset classes and policy paths from H2 2026 through 2027.

Methodology notes

• Macro Scenario AnalysisGeopolitical Conflict and Energy Price Scenario

  Uses conflict escalation or de-escalation as the core variable to assess the Brent price path.

  The report compares two-way risks: oil prices could fall back quickly if conflict eases, or rise above $100 if there are more attacks on oil tankers and Middle East infrastructure.

• Inflation DecompositionDecomposition of Temporary Drivers of Core PCE

  Distinguishes underlying inflation from temporary or measurement-related factors such as software, accessories, energy pass-through, and tariff pass-through.

  The report argues that US core PCE is high relative to core CPI, trimmed-mean PCE, and peer G10 economies, partly because of price measurement issues and US-specific shocks.

• Central Bank Reaction FunctionComparison of FOMC, ECB, and BoE Policy Paths

  Uses inflation, unemployment, financial conditions, and communication mechanisms to assess policy rate paths.

  The report believes the probability of a near-term Fed hike has declined, the ECB may still deliver a second hike in September, and the BoE will not hike this year and may cut three times in 2027.

Asset mapping & comparison

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

• Brent Crude

  Asset directly affected by escalating Middle East conflict

  Strengths

  If supply risk persists, oil prices have upside elasticity.

  Weaknesses

  If the conflict eases and Gulf exports recover, oil prices could fall quickly.

  Comparison

  The current futures path is above Goldman Sachs' 2026Q4 and 2027 forecasts.

  Risks

  More attacks on tankers and infrastructure could push oil prices back above $100.

• US Rates

  Driven by core inflation and FOMC policy expectations

  Strengths

  Improving inflation lowers the probability of a July hike.

  Weaknesses

  If inflation is significantly above expectations or unemployment below expectations, further hikes could still occur.

  Comparison

  Goldman Sachs' Fed path is below market pricing.

  Risks

  Insufficient policy communication could lead to excessive volatility in financial conditions.

• European Rates

  Affected by divergence between ECB and BoE policy

  Strengths

  Goldman Sachs expects limited room for further ECB hikes after a second September hike, and no BoE hike this year.

  Weaknesses

  A rebound in energy prices could increase inflation pressure.

  Comparison

  Goldman Sachs is more dovish than the market on the ECB and especially the BoE.

  Risks

  UK fiscal constraints and energy shocks could alter the policy path.

• Equity Market

  Affected jointly by the AI trade, earnings season, and geopolitical risk

  Strengths

  The equal-weight S&P 500 reached a new high amid a strong start to the Q2 earnings season.

  Weaknesses

  The AI trade pullback and Middle East conflict are weighing on most cap-weighted indexes.

  Comparison

  Goldman Sachs believes the AI economic outlook is positive, but market valuations have already run ahead of the macro backdrop.

  Risks

  Cooling AI enthusiasm could drag on consumer growth through the equity wealth effect.

• CNY

  Affected by the global FX environment and China policy expectations

  Strengths

  Goldman Sachs FX strategists expect CNY to continue appreciating.

  Weaknesses

  China's growth is highly dependent on exports and vulnerable to external growth shocks.

  Comparison

  The current environment is also seen as favorable for carry strategies.

  Risks

  A global growth shock originating in the Middle East or elsewhere could affect China's exports and exchange rate path.

• Gold

  Affected jointly by central bank purchases, energy, and rates

  Strengths

  A renewed acceleration in central bank purchases could support a rebound in gold prices.

  Weaknesses

  Subject to short-term disturbances from energy and rate markets.

  Comparison

  Among commodities outside energy, gold is viewed by Goldman Sachs commodity strategists as being supported by central bank demand.

  Risks

  Higher rates or changes in risk appetite could pressure gold prices.

Key data

• Goldman Sachs Brent Forecast$80/bbl in 2026Q4 and $75/bbl in 2027The current Brent futures path is above this forecast, and risks are skewed upward on net.
• US H1 Growthabout 2.25%The report estimates the US economy grew at a near-trend pace in the first half.
• Estimated Underlying US Job Growth73kRevised down from 130k a month ago.
• US Unemployment Rate4.2%The report believes the recent decline was mainly driven by an unusually sharp drop in labor force participation, which may reverse in coming months.
• GS Wage Tracker3.4%Below the 4% wage growth rate consistent with a 2% inflation target under a 2% productivity trend assumption.
• Estimated US June Core PCE0.18% month-over-month, 3.3% year-over-yearCore CPI was -0.02%/2.6%, and trimmed-mean PCE was 0.14%/2.3%.
• G10 Core Inflation Ex-US2.1%It continued to decline even with the rise in energy prices in March-April.
• China Q2 GDP4.3%Below expectations, confirming slower growth this year.
• China Full-Year 2026 Growth Estimate4.6%Goldman Sachs says this forecast has been lowered.

Impact & implications

From an investment perspective, energy prices and geopolitical risk remain the key short-term disturbances; if the conflict eases, oil prices and inflation pressure may fall back, but if the conflict spreads, oil, rates, and risk-asset valuations could face repricing. In equities, Goldman Sachs remains positive on the AI macro outlook, but believes valuations have run ahead of macro fundamentals, recommending themes tied to consumer experience, strong earnings growth and ROE, solid balance sheets, and M&A candidates. In rates, the market may have priced in too much tightening, but as long as Middle East risk remains prominent, this mispricing may not correct quickly. In FX, the environment is favorable for carry strategies, while CNY is expected to continue appreciating. In credit, AI-related debt issuance may lead to modest spread widening. In commodities, a re-acceleration in central bank gold buying could support a rebound in gold, though energy and rates still pose short-term risks.

Risks

• Further escalation of the Middle East conflict, with more attacks on tankers and energy infrastructure.
• Persistently high oil prices suppressing US consumer spending.
• Cooling in the AI trade dragging on US consumption growth through the equity wealth effect.
• US inflation or unemployment paths deviating from expectations, forcing the Fed to reconsider hikes.
• China's growth is highly dependent on exports and vulnerable to global growth shocks.
• Rising AI-related debt issuance may lead to modest widening in credit spreads.

What to watch

• The July 28-29 FOMC meeting and Chair Warsh's communication on the economic outlook and reaction function.
• The July 23 ECB meeting and whether it delivers a second hike in September.
• Implementation of UK fiscal rules and the BoE's 2027 rate-cut path.
• Whether the Middle East conflict affects tanker shipping and energy infrastructure.
• Whether the divergence among US core PCE, core CPI, and trimmed-mean PCE converges.
• US labor force participation, unemployment, and household employment market indicators.
• Signals from China's July Politburo meeting on easing rhetoric and the use of fiscal buffers.