Goldman Sachs U.S. Risk Premium Model: Three Key Drivers Explain the Market’s Moves

Goldman Sachs’ proprietary U.S. equity risk premium framework decomposes market valuation and price action into three primary components (chart below):

1. U.S. Growth Expectations (dark blue line) Measures changes in consensus forecasts for future U.S. economic growth.
2. U.S. Monetary Policy Expectations (light blue line) Captures the market’s pricing of tighter or looser Fed policy (hawkish vs dovish).
3. U.S. Risk Premium (red line) The extra return investors demand to hold U.S. risk assets (equities) over risk-free rates — essentially a proxy for investor fear, uncertainty, and sentiment.

Here is what the latest data is telling us:

(Sources: Goldman Sachs Global Investment Research)

1. Risk Premium Has Been Falling Steadily (Red Line)

The red line peaked around 10 in May 2025 and has declined almost continuously since, stabilizing near 5 in recent months.

Interpretation: Investors are demanding less compensation to own U.S. risk assets. This reflects declining perceived tail risks and improving sentiment — a pattern that has closely mirrored the drop in the VIX (the market’s short-term fear gauge) over the same period.

2. Monetary Policy Remains Extremely Hawkish (Light Blue Line)

The light blue line has stayed deeply negative, hovering around -10 for most of 2025 before showing the first modest uptick in October.

Interpretation: Markets have priced in persistently tight Fed policy for the bulk of the year. The slight improvement since October coincides with the Fed’s announcement that it would end balance-sheet reduction (QT) — a small but meaningful dovish shift. Still, policy expectations remain among the most restrictive in decades.

3. Growth Expectations Improving but Now Rolling Over (Dark Blue Line)

The dark blue line bottomed near zero in April 2025, recovered to roughly +5 mid-year, and has recently begun to weaken again while still in positive territory.

Interpretation: Despite the hawkish policy backdrop, growth expectations improved earlier in 2025. The recent pullback aligns with renewed recession fears tied to the Fed’s December “no-cut” signal and persistent high real rates.

The Big Picture Risk

The primary danger remains the prolonged and extreme monetary tightness (light blue line near historic lows) suppressing growth expectations (dark blue line trending lower). No economy can sustain real rates near 4% indefinitely without consequences.

While the risk premium has fallen and sentiment has stabilized, the combination of still-hawkish policy and softening growth forecasts keeps recession risks elevated over a 6–18 month horizon.

In short: the Goldman Sachs model shows that lower risk premiums have supported equities, but the underlying growth-policy tension has not been resolved — and until it is, the path of least resistance for risk assets remains fragile.