Traders work at the Goldman Sachs booth on the floor of the New York Stock Exchange.

The Fed is likely to "respond to the economic implications of material and sustained changes in financial conditions by adjusting the funds rate path. We don't know yet whether the recent change will be sustained, but it is material," Hatzius wrote.

In a note this weekend, Goldman chief economist Jan Hatzius conceded that while the central bank is still likely to increase its benchmark short-term rate in December, another move in March seems unlikely.

The bank's economists still think the market has it wrong on Fed policy, and they see three increases in 2019.

Tightening financial conditions and intensified skittishness over trade will cause the Federal Reserve to follow a less aggressive path when it comes to hiking rates, according to Goldman Sachs.

"December is still very likely (in our view 90%). However, we think the probability of a move in March has now fallen to slightly below 50%," he added.

Until the change, Hatzius had the most aggressive Fed call on Wall Street, with four quarter-point increases likely in 2019. That was even more hawkish than the current forecast of three hikes from officials on the Federal Open Market Committee, which sets rates for the central bank and announces its next decision on Dec. 19.

Markets, though, have slashed their expectations following the stock market turmoil over the past two months that has coupled with an intensified trade skirmish between the U.S. and China and expectations that global growth will slow in the year ahead.

The market now is pricing a 73 percent chance of a December hike, but only a 48 percent probability that the Fed hikes rates at all in 2019, according to the CME's tracker. Looking further out, futures contracts indicate a growing possibility of a rate cut heading into late 2020 and early 2021. The fed funds rate is currently in a range of 2 percent to 2.25 percent.

Goldman thinks investors are overly concerned about how tight financial conditions will get.

"In our forecast, the economy continues to grow above trend for most of the year, the unemployment rate falls further below the Fed's estimate of its longer-term level, wage and price inflation gradually move higher, and we see a return to quarterly hikes in June that last through the end of 2019," Hatzius said.

He discounts the likelihood of a recession anytime soon, saying financial imbalances and economic overheating do not appear present. The employment picture remains strong and inflation is likely to pick up, he said.

"We therefore think that the storm will pass and this will keep Fed officials on a normalization path, albeit a more tortuous one than up to now," Hatzius wrote.