Markets and central banks are both starting to "hawkish turn." Goldman Sachs explores: how to hedge?

Energy price shocks combined with a hawkish shift from central banks are reshaping global asset pricing logic, presenting investors with an unprecedented hedging dilemma.

Goldman Sachs strategists Dominic Wilson and Kamakshya Trivedi warn in their latest report that the hawkish repricing by markets and central banks has clearly overshot, with significant asymmetry in interest rate pricing, and the front-end yields offer attractive long opportunities under various scenarios.

Meanwhile, as Federal Reserve officials send vague signals about the possibility of rate increases or decreases, market expectations for the conclusion of the rate-cutting cycle continue to heat up, further compressing the upside potential for risk assets.

In terms of asset prices, the interest rate market has undergone the most severe adjustments in this round of shocks, while the stock and credit markets have so far maintained overall resilience, failing to fully price in the deep tail risks of downside. Goldman Sachs believes that, given the extremely wide distribution of scenarios, investors’ primary task is to selectively build hedges while maintaining flexible positions.

The hawkish repricing has clearly overshot

Goldman Sachs’ report indicates that since the surge in energy prices, the hawkish repricing at the front end of the interest rate curve has been the most prominent feature of all market movements. For example, in the UK, market pricing shifted from an expected rate cut of 54 basis points within the year to an expectation of a rate hike of 102 basis points; Hungary shifted from an expected cut of 77 basis points to an expected hike of 118 basis points. Before signs of easing in the situation on the 23rd, the market had priced in a 92 basis point hike for the ECB, a 23 basis point hike for the Fed, a 128 basis point hike for South Korea, and a 70 basis point hike for Mexico.

This aggressive repricing has been driven not only by energy prices themselves but also by the central banks’ unusually hawkish statements. Federal Reserve Chairman Powell has explicitly stated that a moderately restrictive policy remains appropriate; the Bank of England’s Monetary Policy Committee had no votes in favor of a rate cut; several ECB officials have publicly stated that the upcoming April meeting may discuss rate hikes.

According to The Wall Street Journal, subtle but significant shifts in signals from within the Fed have emerged. Chicago Fed President Austan Goolsbee has become one of the first officials to explicitly mention the possibility of rate hikes, stating, “If inflation performs poorly, I can envision scenarios that would require rate hikes.” Previously seen as dovish, Governor Christopher Waller also stated that the inflation risks from the Iran war prompted him to support maintaining rates in March. San Francisco Fed President Mary Daly warned that the dot plot could convey a risk of “false certainty,” indicating that there is no single most likely path for interest rates.

Central banks may be “fighting a war”

Despite the strong momentum of hawkish repricing, the two Goldman Sachs strategists emphasize that this round of pricing has significantly exceeded reasonable ranges under most baseline scenarios, presenting a core judgment: part of this aggressive repricing stems from the “psychological scars” left by the underestimated inflation shock of 2022, with G10 central bank officials showing heightened awareness of indirect effects, second-round effects, and the risk of unanchoring inflation expectations, similar to that time.

There are several important differences between this round and 2022: fiscal impulses are clearly weaker than before, any fiscal support is more targeted; the widespread supply chain disruptions caused by the pandemic have not reoccurred; and the labor market is significantly weaker than in the post-pandemic period.

It is noteworthy that emerging market central banks—typically more sensitive to inflation shocks—are currently presenting relatively balanced statements, as seen in Brazil, the Czech Republic, and Hungary. This phenomenon is considered one of the “signals” of current excessive hawkish pricing.

Meanwhile, according to Bloomberg, Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, pointed out that the front end of the Treasury yield curve no longer views energy prices as a follow-up inflation risk but is more focused on economic growth and the downside risks to risk assets.

Recently, while oil prices continued to rise and U.S. stocks faced selling pressure, U.S. Treasury yields did not rise as usual but instead showed a significant decline, completing a clear logical decoupling. Analysts believe that the market is increasingly focused on deteriorating expectations for the economic fundamentals.

From a fundamental perspective, the pricing of the Fed’s rate hike risks and expectations for multiple rate hikes in Europe are both overly hawkish, with front-end rates offering clear asymmetric long opportunities.

Front-end rates: the most prominent asymmetric opportunities

The asymmetry in the interest rate market has been the clearest area of change since this round of shocks, especially for investors who can withstand short-term volatility, as increasing front-end longs or extending duration in their portfolios is highly attractive.

Specifically, investors can sell put options on front-end rates in Europe and the UK, with the breakeven point corresponding to multiple rate hikes; hedging against deeper declines in rates (or related declines in USD/JPY) and joint scenario hedging for rates and stocks moving down together are also worth incorporating into a mid-term risk management framework.

Historical experience from the 1990s shows that even if it ultimately proves that rate hikes were excessive, yields are unlikely to rebound significantly before energy prices show a clear decline—although yields may peak before oil prices. This pattern further reinforces the logic of establishing longs at the front end currently.

U.S. stocks and credit: downside tails still underestimated

Compared to the dramatic adjustments in the interest rate market, U.S. stocks and credit markets have thus far clearly underestimated the pricing for deep downside tail risks.

The implied volatility of near-term S&P 500 put options remains far below levels seen during the tariff shock in April 2025 and lower than levels during the economic growth panic in August 2024. The rapid policy reversals after the tariff shocks have made investors more resistant to downside hedging, but the current situation clearly presents a more complex resolution path.

Considering the convex characteristics of oil price trends and the uncertainty of growth outcomes, the deep downside tails in U.S. stocks and credit remain undervalued. The report suggests that maintaining or even increasing down protection positions in stocks, credit, and cyclical currencies remains reasonable under the current baseline scenario, and continuing to favor the upside of long-term implied volatility in stocks.

For options hedging, while the prices of call options for U.S. and European stocks (and European currencies) are somewhat expensive, they are not extreme compared to historical instances of major declines; if the upside is constrained by pre-existing concerns (AI disruptions, high valuations, turmoil in private credit), spread call option strategies are also reasonable.

Wide scenario distribution, paths remain highly uncertain

The core challenge facing the current market is that the scenario distribution is unusually wide, and even minor changes in the perception of tail risks can trigger dramatic bidirectional fluctuations in asset prices.

In an optimistic scenario, a rapid easing of the situation would first drive a rebound in previously pressured assets, including European and cyclical assets, non-USD currencies, and front-end rates, with Korean stocks and Hungarian forints potentially leading the recovery.

In a pessimistic scenario, if oil prices rise further and trigger clear recession fears, it would have a broader impact on risk assets, and assets that have been relatively resilient, such as copper, Brazilian reais, and Australian dollars, would also be hard to escape. At that point, G10 safe-haven currencies like the yen and Swiss franc are likely to strengthen, and the center of gravity for yields would systematically decline.

Between the extremes, a middle path may see some market recovery, but the differentiation in energy trade conditions will be more distinctly reflected between currencies and stocks, with assets from energy-exporting countries (such as Brazilian stocks and Australian dollars) still likely to benefit relatively.

Furthermore, the accumulated worries in the market prior to the Iran war—AI disruption expectations, high valuations, volatility in private credit—have not dissipated, and once the geopolitical situation marginally eases, these issues may quickly return to the market’s focus, becoming a major suppressive force for any rebound.

Risk warning and disclaimer

        Markets are risky, and investments should be made cautiously. This article does not constitute personal investment advice and does not take into account the individual user's specific investment objectives, financial situation, or needs. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investing based on this information is at one's own risk.