【US Interest Rates】Energy Shocks Increase Stagflation Risk; Pimco Expects Fed to "Hold Fire" for Most of 2026

Amid ongoing conflicts in the Middle East and rising oil prices, the market generally expects major global central banks to adopt a hawkish stance. However, asset management firm Pimco predicts that the Federal Reserve will keep interest rates unchanged for most of this year, resuming an easing cycle only once the situation becomes clearer. They also advise investors to seize bond market opportunities that go against the mainstream narrative.

This month, the global bond market experienced its worst sell-off since October 2024, with yields on U.S., European, and UK government bonds rising sharply. The market is preparing for possible rate hikes by major central banks later this year. However, Pimco economist Tiffany Wilding and Global Fixed Income Chief Investment Officer Andrew Balls point out that energy supply shocks are significantly increasing the risk of stagflation.

Inflation May Be Temporary

In their latest report, they emphasize that major central banks are unlikely to fully follow the market’s rapid repricing of interest rate paths. The tightening effects will more directly impact vulnerable households, small and medium-sized enterprises, and credit markets.

“The market’s instinctive reaction to tighter financial conditions and more hawkish monetary policy has largely done the ‘hawkish’ work for central banks. If inflation is only temporarily rising and economic signs weaken, central banks may need to shift more decisively toward easing.”

Therefore, Pimco recommends increasing allocations to interest rate-sensitive global bonds, believing that the current bond market correction has created an attractive entry point for long-term investors.

At the March Federal Reserve meeting, the Fed kept the benchmark interest rate unchanged at 3.5% to 3.75%. Although Fed officials have taken a cautious stance amid the risks to global energy supply and high oil prices caused by the Iran conflict, viewing recent energy shocks as temporary, this does not necessarily mean the central bank will maintain a long-term tightening policy.