TD Securities strategists say the Federal Reserve is facing conflicting signals as the Iran conflict triggers an oil shock. They describe the US economy as mixed, with the Fed’s dual mandate still in tension at the start of 2026. They expect the Fed to keep rates on hold in the near term, with a Committee that could lean hawkish by keeping financial conditions tighter. They also expect rate cuts later in 2026 if conditions allow.

Energy Shock And Inflation Expectations

They say Fed leaders may treat the energy shock as temporary if long-run inflation expectations stay stable. They add that second-round effects on core inflation would need to remain largely contained. They compare the current backdrop with 2022, saying monetary and fiscal policy are not overly loose. They also say the labour market is no longer extremely tight, there is no excess-savings-driven pent-up demand, and global supply chains are under less stress. They note the Middle East situation remains fluid and that several paths could change the outlook, leading to either a more hawkish stance or faster easing. They add that a resilient US economy gives the Fed room to wait. The Federal Reserve is in a tough spot as the conflict in Iran pushes WTI crude oil prices past $115 a barrel, causing a significant shock. This recent surge lifted the last headline CPI reading to 4.1%, creating pressure to act. We believe the Fed will look through this, however, as core inflation remains more contained at 3.2%, allowing them to remain in a holding pattern.

Trading Implications For Rates

This patient stance is possible because the underlying economy is much softer than in prior years. February’s jobs report showed a weaker-than-expected gain of only 150,000, and the unemployment rate has ticked up to 4.2%. This gives the central bank space to wait and assess the downside risks to growth before reacting to the energy price spike. Looking back from our current perspective, the economy is in a starkly different place than it was during the 2022 inflation episode. The period of disinflation through 2025 left the economy without the overheating labor market or excess consumer demand that forced the Fed into aggressive action back then. This history gives them the flexibility to not overreact to the current oil shock. Given the high degree of uncertainty, traders should consider strategies that benefit from volatility itself. With the geopolitical situation remaining so unpredictable, options plays that profit from a large price swing in either direction are more sensible than betting on a specific outcome. The MOVE index, a measure of bond market volatility, is reflecting this tension as it hovers near its yearly highs. For rates traders, the most compelling position may be to anticipate a steeper yield curve over the medium term. The Fed’s plan to hold rates steady now while still aiming for cuts later in 2026 should keep short-term rates anchored. This makes trades that profit from the widening gap between two-year and ten-year yields an attractive way to position for the eventual policy shift. Create your live VT Markets account and start trading now.

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