Iran oil shock has put Fed rate cuts off the table and hikes back on, Pimco says
The desk interprets Pimco's recent commentary as a significant shift in the Fed's interest rate outlook, suggesting that the ongoing energy shock from the Iran conflict may necessitate rate hikes rather than cuts. Per the full note source, Pimco's CIO Dan Ivascyn emphasized that the inflationary pressures from rising energy prices could render rate cuts counterproductive, a sentiment echoed by Franklin Templeton's CEO Jenny Johnson. This perspective is reinforced by the Fed's preferred inflation measure, which hit 3.5% in March, its highest in nearly three years, indicating that the central bank's monetary policy calculus is becoming increasingly complex. The recent rise in the two-year Treasury yield by approximately 50 basis points since the onset of the conflict further underscores tightening financial conditions that could dampen demand and influence the Fed's decision-making process.
What the desk is arguing
The desk frames this as a pivotal moment for the Federal Reserve, where the implications of the Iran war's energy shock could lead to a reassessment of rate cuts. The commentary from Pimco and Franklin Templeton suggests that inflation dynamics are shifting, making rate hikes a possibility rather than a distant concern.
Supporting this view, the two-year Treasury yield has risen to 3.87%, reflecting a significant repricing of the Fed's rate path and indicating market expectations of tighter monetary policy. This shift in sentiment is crucial as it aligns with the Fed's recent decision to hold rates steady amidst the highest level of internal dissents since 1992, suggesting a growing divide among policymakers regarding the appropriate response to inflationary pressures.
Where it sits in our coverage
Our consensus target for the USD is 1.075, with a range of 1.04 to 1.12. Notable firms include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns closely with jpmorgan, which is positioned at the upper end of our range, while bofa presents a more cautious stance at the lower bound. The desk's interpretation of the Fed's potential pivot towards hikes contrasts with the more dovish outlook some firms maintain.
How other firms see it
Firms like jpmorgan and goldman appear to be aligned with the notion that the Fed may need to act more aggressively in response to inflation, while bofa and citi maintain a more conservative approach, advocating for a wait-and-see strategy. This divergence highlights the uncertainty surrounding the Fed's next moves.
Key indicators to watch include the trajectory of the USD/JPY, which may reflect the spillover effects of the Fed's rate decisions, and the evolving dynamics of the crude oil market, which are heavily influenced by geopolitical tensions and inflationary pressures.
Key takeaways
- 01Pimco and Franklin Templeton warn that the Iran war's energy shock could necessitate Fed rate hikes.
- 02The Fed's preferred inflation measure reached 3.5% in March, complicating the rate-cut narrative.
- 03The two-year Treasury yield has risen by approximately 50 basis points since the conflict began.
- 04Market expectations are shifting towards tighter monetary policy amid rising inflation concerns.
Market implications
Traders should monitor the USD/JPY for potential volatility as the Fed's rate path becomes clearer. A sustained move above 3.87% in the two-year Treasury yield could signal further tightening in financial conditions, impacting risk assets and commodities.
Pimco's CIO warned the Financial Times (gated) that the Iran war's energy shock could make Fed rate cuts counter-productive and may even necessitate hikes, with Franklin Templeton echoing the concern. Summary: Pimco chief investment officer Dan Ivascyn told the Financial Times at the Milken Institute conference in Beverly Hills that rate cuts by the Federal Reserve would be counter-productive given the inflation dynamics created by the Iran war's impact on energy prices, and said hikes could not be ruled out for the United States Franklin Templeton chief executive Jenny Johnson, in a separate interview at the same conference, said inflation would be harder to control and that it would be difficult for the Fed to cut rates, adding that investor appetite for inflation-protected assets was rising The Fed's preferred inflation measure, the personal consumption expenditures index, registered 3.5% in March, its highest level in almost three years, amid energy price pressures stemming from the Hormuz disruption The Fed held rates steady for a third consecutive meeting last month in a decision that featured the highest number of internal dissents since 1992, though it retained language suggesting the next move could still be a cut The two-year Treasury yield has risen around 0.5 percentage points since the war began in late February to 3.87%, reflecting a significant repricing of the Fed rate path Kevin Warsh, Trump's nominee to replace outgoing Fed chair Jay Powell whose term ends on May 15, is expected to be confirmed by the Republican-controlled Senate; both Pimco and Franklin Templeton expressed confidence he would maintain sufficient independence on rate-setting and balance sheet management --- The intervention from two of the world's largest fixed income and asset managers carries significant weight for markets, as it frames the Iran-driven energy price surge not merely as a supply shock but as a structural inflation problem that central banks may need to actively tighten against. A Fed rate hike scenario, even if still a tail risk, would strengthen the dollar and historically weigh on commodity prices including crude, creating a countervailing force to the geopolitical risk premium currently supporting oil.
The jump in the two-year Treasury yield of around 50 basis points since the war began is already tightening financial conditions in a way that could dampen demand. With the Fed's preferred inflation gauge running at 3.5% in March, its highest in nearly three years, the energy channel from Hormuz to Main Street is now firmly part of the monetary policy calculus, adding a further layer of complexity to crude's price outlook beyond the purely supply-side disruption story. This article was written by Eamonn Sheridan at investinglive.com.
Sources & References
How we cover this story