Iran war could force Fed to raise rates, Pimco warns

The Iran war could force the Federal Reserve to abandon its easing bias and raise interest rates, Pimco has warned, as the Middle East energy shock threatens to entrench inflation even as recession risks mount.

In an analysis published 29 April, Pimco economist Tiffany Wilding said the Fed’s April decision to hold rates at 3.5 per cent to 3.75 per cent was expected. More significant were the three dissents on the Federal Open Market Committee, the largest number in years, which signalled growing unease inside the central bank about the implicit commitment to eventual rate cuts. The committee’s policy statement retained language that markets have long read as a bias toward further easing, language the dissenters wanted stripped.

“Our view remains that the next move will be a rate cut, but the timing is far from clear,” Wilding wrote. “If the Iran conflict and energy shock appear more persistent, it could take longer for core inflation to more clearly begin to moderate back toward the Fed’s target, complicating the decision to ease monetary policy.”

The dissenters, Wilding noted, wanted the committee to signal more strongly that the next rate move could go either way. One of the three dissents came from Governor Stephen Miran, who favoured easier policy and has dissented consistently in that direction. The other two leaned hawkish, preferring to remove the implicit easing language from the statement entirely. That trio marks the deepest split on the committee since the post-pandemic inflation fight of 2022.

Chair Jerome Powell acknowledged the shift at his post-meeting press conference, saying changes to the statement language were “a close call” and that more members had supported hawkish revisions than at the March meeting. “Fed policy is in a good place to react to the economic implications of the energy supply shock, which poses risks to both sides of the Fed’s dual mandate,” he said.

Powell’s last stand

The meeting was almost certainly Powell’s last as chair. He committed to remaining as a governor until investigations into the Fed building renovation costs and other matters concluded with “transparency and finality,” but declined to set a timeline. He also warned that any attempt to remove Federal Reserve Bank presidents over their policy votes would be “the beginning of the end” for the institution’s independence.

Kevin Warsh, the incoming chair, criticised the Fed at his Senate confirmation hearing for acting too slowly on inflation in 2022 and pointed to trimmed-mean and median inflation measures, which currently run below core personal consumption expenditures inflation, as evidence of a modestly dovish lean. Pimco expects the Warsh transition to affect communication and market interpretation more than the rate trajectory itself.

“Our working assumption remains that Warsh’s current bias is toward cuts, and that the Fed will remain an independent institution under his watch,” Wilding wrote.

Global central banks hit pause

The Fed is not alone. Six of the ten most heavily traded currency central banks left rates unchanged at their April meetings, according to Reuters data published on 6 May: the Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Reserve Bank of New Zealand, and Bank of Japan. Four others held no rate-setting meetings at all.

The result: zero rate cuts from the G10 in the first four months of 2026, compared with 850 basis points of easing across the full year 2025 and 800 basis points in 2024. Australia’s central bank bucked the trend, delivering two hikes totaling 50 basis points, including one on 5 May.

Among 18 major developing economies tracked by Reuters, Brazil and Russia cut rates by a combined 75 basis points in April, the first monthly total below 100 basis points in a year. Ten of the 11 other emerging-market central banks that held meetings kept rates unchanged. The Philippines delivered a rate hike after inflation data blew past all expectations and the peso hit near-record lows.

“Oil prices have surged and markets are pricing higher inflation and rate hikes, even if central banks stayed on hold,” said Christian Keller, an economist at Barclays. Emerging economies face outsized pressure because energy and food account for larger shares of their inflation baskets.

Yet analysts at M&G cautioned against reading the pause as a permanent shift. “Monetary policy now is at not only positive levels, but there is plenty of room for central banks to ease if they need to ease,” said Carlos Carranza of the firm’s emerging market debt team.

Two paths for the Fed

Pimco’s baseline assumes energy prices eventually moderate, allowing the Fed to cut a few more times and bring the policy rate toward its estimate of the neutral rate, roughly 3 per cent. That would narrow the gap between the current 3.5 per cent to 3.75 per cent range and where the Fed’s own median projection lands.

Wilding identified key differences between today’s inflation picture and the 2021–2022 spike: the post-pandemic episode was amplified by large federal transfers to households and businesses, plus an extremely tight labour market. Neither factor is present now. That structural difference, she argued, should help contain the pass-through from higher energy costs into broader services prices, the channel that proved most persistent and painful in the last inflation cycle.

In the risk scenario, however, a prolonged disruption to physical energy supply from the Middle East would produce stark trade-offs. In that world, Wilding wrote, “an initial surge in global inflation would likely delay the central bank’s reaction to weaker activity,” and the Fed would face the uncomfortable choice of holding rates high into a slowing economy or cutting into rising prices.

The Strait of Hormuz, which normally carries about 20 million barrels of oil per day, roughly a fifth of global supply, has been mined by Iran since the conflict began on 28 February. Brent crude has risen above $100 a barrel. US consumer price inflation was running at 3.3 per cent in March, well above the Fed’s 2 per cent target, and the labour market remains steady with unemployment at 4.3 per cent and 178,000 jobs added in March.

Markets brace for no landing

The Federal Reserve is quickly running out of reasons to cut interest rates, and a separate Fed inflation tracker has warned that prices are accelerating as the Iran war fuel shock persists. The IEA has warned energy volatility is permanent after the Hormuz closure, a development that undermines the assumption embedded in Pimco’s baseline that energy prices will eventually moderate.

Traders as of mid-April placed a greater than 97 per cent probability on a hold at the April FOMC meeting, with a small but notable 2.6 per cent pricing in a 25-basis-point hike, according to CME FedWatch.

Former Pimco chief executive Mohamed El-Erian told Fortune in April that the Fed’s forward guidance had lost credibility. “It’s crazy. This should not happen. The whole point of forward guidance is predictability and stability,” he said.

UBS chief economist Paul Donovan noted that central bankers have no visibility into the trajectory of the war. “It is too soon to identify potential second-round effects,” he said.

With the next FOMC meeting approaching and Warsh preparing to take the chair, the Fed’s rate path hinges on a variable outside any central banker’s control: the duration and severity of the conflict in the Gulf.