A significant shift for global financial markets this month, amid Middle East conflict, is undoubtedly investors beginning to bet that the Federal Reserve's next move will be an interest rate hike. However, many industry insiders indicate that persistent fragility in the U.S. labor market and the downside risks to economic growth from surging oil prices may make it difficult for the Fed to actually implement a rate increase. Pricing in the interest rate futures market shows that, as of March 19, federal funds rate futures for the first time implied a 6% probability of a Fed rate hike in April, and have remained in positive territory since. This marks the first time since December 2023 that investors have perceived the likelihood of the central bank hiking rates at its next policy meeting as higher than the chance of a cut. This shift in investor sentiment highlights the significant uncertainty the U.S. economy faces from potential ripple effects of the U.S.-Iran conflict and the oil price surge. Yet, economists and analysts closely watching the Fed suggest the probability of a near-term rate hike remains extremely low.
Is pricing in hikes one thing, but implementation another? Veronica Clark, an economist at Citigroup, stated, "Certainly, an oil shock is a new inflation risk, but if it has any other effect, it is also a negative growth shock, and could even be negative for employment." Fed policymakers appear to share this view. In the first dot plot released after the outbreak of the Middle East conflict, none of the 19 Fed policymakers forecast a rate hike this year, with only one projecting a hike in 2027. In fact, most officials still signaled further rate cuts. Fed Chair Jerome Powell, speaking at a press conference following last week's policy meeting, told reporters that the possibility of the next move being a hike was indeed discussed. However, he added that, nonetheless, the "vast majority" of FOMC participants still do not see a hike as their baseline scenario. Fed officials subsequently were quick to point out that the inflationary impact of an oil price shock is likely temporary, and that it takes months for interest rate changes to affect the economy. This implies that the downward pressure on inflation from a rate hike might only materialize after price increases have subsided or even reversed.
Many industry analysts also note that to justify a rate hike, the surge in energy prices would need to persist for an extended period, spill over into other goods and services, and be accompanied by wage increases driven by labor market conditions. While memories of the high inflation shock triggered by the Russia-Ukraine conflict in 2022 may concern investors, the economic backdrop then was starkly different. The Fed's preferred inflation gauge was already above 6% at the start of that year, and the unemployment rate had fully recovered from the pandemic. Against a backdrop of a tight labor market, businesses competing to hire further exacerbated inflationary pressures. In contrast, as we move into 2026, the U.S. labor market is experiencing a prolonged hiring slowdown. Despite signs of stabilization late last year, officials were surprised by a decline in non-farm payrolls in February.
Furthermore, another factor calls the prospect of rate hikes into question: the White House might pressure the Fed to lower rates, particularly if Kevin Warsh, a nominee of former President Trump, is confirmed by the Senate as the next Fed Chair. Analysts led by Aditya Bhave at Bank of America wrote in a recent research note that given Warsh's recent comments emphasizing the urgency of rate cuts, it is difficult to imagine him reverting to a hawkish stance upon assuming the chairmanship.
So, how should one view the rate hike expectations emerging in the interest rate futures market? Molly Brooks, a rates strategist at TD Securities, suggests that some of this trading is less a prediction and more like an "insurance policy" against an unlikely but highly disruptive outcome. Brooks pointed out, "Before the initial strikes on Iran, we were all looking at the fundamentals, and there was a bias towards cuts. Once people saw the oil shock, inflation concerns came roaring back."
PIMCO Favors a Contrarian Trade: Buying Bonds! Notably, as Middle East conflict and a shift towards more hawkish global central bank policy expectations increase market volatility, Pacific Investment Management Co. (PIMCO) is actively promoting "contrarian investment opportunities." This month, global bond markets suffered their worst sell-off since October 2024, as surging oil prices due to the conflict and the risk of resurgent inflation prompted traders to prepare for potential rate hikes later this year in the UK, Europe, and the U.S. However, PIMCO is advising investors to increase their allocations to more rate-sensitive global bonds.
In the view of PIMCO economist Tiffany Wilding and Global Chief Investment Officer for Fixed Income Andrew Balls, the energy shock increases the possibility of stagflation – a combination of sluggish growth, high unemployment, and high inflation. They wrote in a report, "Central banks are unlikely to keep pace with the market's recent repricing of policy rate expectations," and the impact will be felt more directly by vulnerable households, small businesses, and credit markets. "In effect, the market's instinctive reaction to tighter financial conditions and more hawkish monetary policy has already done much of the hawkish work for policymakers," they wrote. If inflation continues to climb in the short term and the economy weakens, "central banks may need to pursue more aggressive easing."
During this month's volatile trading, yields on U.S. Treasuries from the 2-year to the 10-year note rose by nearly 50 basis points at one point. Short-term Treasury yields are now approaching 4%, while the 10-year yield hovers around 4.37%, near the top of the 4%-4.5% range that has largely prevailed over the past year. PIMCO also referenced a period of similar volatility in the bond market last year – when the U.S. imposed significantly higher-than-expected tariffs on trading partners, which also triggered a brief spike in Treasury yields. "Similar to the volatility seen after the U.S. tariff announcement in April 2025, the rapid repricing of central bank expectations in response to the Middle East conflict has created localized volatility and contrarian opportunities," Wilding and Balls wrote.
PIMCO's key investment recommendations for the next 6 to 12 months for investors include: PIMCO favors a "modest overweight to duration," meaning increasing allocation to more rate-sensitive global bonds – the firm views the U.S. Treasury market as a recognized 'safe-haven' source of yield, offering portfolio diversification benefits, and "the case for global diversification remains strong" as divergences emerge between countries, which active investors can exploit. Rather than assuming global market trends, investors can benefit from exposures to specific developed and emerging markets that offer attractive real yields and credible policy frameworks. For portfolios with increased equity market exposure, the rise in high-quality bond yields should be seen as a "practical time to consider rebalancing." In private credit, signs of late-cycle credit stress highlight the need for selective sourcing, careful assessment of pricing and liquidity terms, and prioritizing high-quality investments with collateral backing. PIMCO favors Mortgage-Backed Securities (MBS), investment-grade issuers with stable, predictable cash flows, and high-quality securitized credit. PIMCO advises caution regarding "direct loans and bank loans with weak covenants, lower-quality high-yield bond issuers, and many special purpose vehicle structures where liquidity is mismatched with the underlying assets."
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