You should be able to assign the ip range (169.254.0.0/16) to an interface and then use it like a normal IP range, but I would recommend against doing so as this is not the intended use for that subnet.
The firewall can be easily configured to provide a DHCP server on each interface where non-static hosts connect to the network to provide them with a real IP address
I think you are asking if PA NAT supports proxy arp. If so, the answer is yes and it is automatic.
See page 5 in the Understanding Palo Alto NAT documentation.
Proxy-ARP for NAT Pools
The address pools are not bound to any interfaces. If the address pool is in the same subnet as the egress/ingress interface IP address, the firewall will respond to ARP requests received on that interface for the IP addresses configured in the pool. If the address pool is not in the same subnet as the egress interface IP address, you must configure the necessary routes on the upstream devices in order to ensure the response traffic after address translation is routed back to the firewall.
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