In the Fed preview yesterday, I mentioned that Warsh was going to be the noise, while the Board the signal. In fact, the only takeaway from the decision was the more hawkish dot plot as the statement didn’t contain anything and Fed Chair Warsh refrained from giving forward guidance.
The median dot plot showed one rate hike this year and some of those hawkish members pencilled in two rate hikes. By projecting a rate hike, the Fed effectively adopted a tightening bias in the short-term.
The US dollar surged across the board on the more hawkish than expected dot plot (the consensus was looking for no cuts or hikes this year). The market increased rate hike bets immediately with now 40 bps of tightening priced in by year-end. There’s a 36% chance of a hike already in July and 72% probability of a move in September.
The economic data and financial markets will now guide the Fed as Warsh
stated that “financial markets perform best when they react to incoming data
and are less efficient when they have to ask how the Federal Reserve will react
to the incoming data”. He added that “financial markets are the most important
source of information to guide the central bank”.
Trump also posted on Truth Social and, unlike his usual stance under Fed
Chair Powell, did not object to the Fed’s decision. In fact, he said
that “rate hikes could happen,” which sounds like a green light for Warsh
and the Fed to do whatever they deem necessary.
The signal is that the Fed is finally looking to deliver on its price
stability mandate and bring inflation back to the 2% target that it’s been
missing since 2021. If the data says they need to hike, they will.
My expectation is that the negative supply shock caused
by the US-Iran war turns into a positive demand shock now that the war ended and
oil prices dropped significantly. I think that’s going to boost economic activity further
and the markets are already positioning for that scenario.
With the Fed’s tightening bias, it’s going to be harder for the stock market to rally as hard as it did in the past two months (the risk/reward is skewed to the downside). At best, I expect prices to stay in a wide range, at worst, a correction to January 2026 levels.
This should also result in a bear flattening with short-term yields rising faster than long-term ones as long-term yields are going to start looking for signs of economic slowdown to position for eventual rate cuts. Therefore, I expect long-term bonds to finally bottom for good in the next months.
The US dollar should remain bid until we reach the peak in rate hikes pricing. Precious metals are going to have a hard time amid increasing real yields, and a potential selloff in the stock market could make things even uglier.
This article was written by Giuseppe Dellamotta at investinglive.com.
