Warsh's Debut Preview: Fed Dot Plot May Fade, Rate Cut Signals Shift to Hikes

The Fed's quarterly dot plot of rate projections may soon lose its last rate-cut signal, or even be eliminated entirely. Then, markets will focus more on whether Kevin Warsh is indeed the inflation hawk he has claimed to be. If that judgment holds, it may surprise some investors.

The new Fed chair is busy clarifying his stance and listening to staff before his first policy meeting later this month. From his statements on policy direction, markets will not get a simple answer.

Rapid growth in AI investment and energy price spikes from the three-month Iran war have pushed inflation well above target. Coupled with internal uncertainty at the Federal Open Market Committee, futures market sentiment is tense, with expectations that the next Fed rate hike may come before year-end.

In recent months, one of the few remaining arguments for doves has been the possibility of cracks in the labor market, which could be exacerbated by AI-related layoffs or energy-related production cuts. But so far, there are few signs of that.

Instead, the job market appears robust and may even improve further. A large increase in April job openings and private sector payrolls exceeding expectations with 122,000 new jobs in May point to this. The May national nonfarm payrolls report due Friday will test this trend.

The Fed will not hike this month, but may plant the seeds for a hike.

Beyond any signals from Warsh at the press conference, markets will also watch closely whether the Fed's previous statement hinting at another rate cut is removed. At the last rate meeting, three governors voted to remove that language, and at least one recent dove, Fed Governor Christopher Waller, has since joined them.

But the quarterly economic projections from Fed policymakers, including the dot plot projecting future interest rates, could become the focus.

The current median projection is for one more rate cut this year and another in 2027.

Since March, statements by Fed officials suggest that the rate cut expectation for this year is likely to disappear from the dot plot. Whether 2027 will see a cut or even a hike, as markets expect, might have the biggest impact.

Of course, ironically, Warsh's distaste for so-called forward guidance likely pushes him to abolish the dot plot entirely. Doing so would win him support from many, including his predecessor Jerome Powell, who remains a Fed governor.

If the prospect of further easing is removed and guidance is halted, leaving the market to judge based on incoming data, the rate market could become tighter and more volatile in the second half of the year.

Of course, some investors still hope that an eventual end to the Iran war will put easing back on the table, or that the impact of energy tightness on real income will be enough to curb household demand and thus control other prices.

But many believe the tide has turned.

Rate cut plans abruptly halted

Tim Duy, economist at SGH Macro, believes the inflationary consequences of rising energy prices now dominate the impact on growth, and as the Fed begins to realize that the last rate cut in December was a mistake, the stance within the FOMC is rapidly shifting.

"Fed officials are increasingly aware of the risk of inappropriate monetary policy and are quickly turning hawkish to pave the way for a rate hike," he said.

"The old Warsh would have raised rates early," he added, referring to Warsh's long-held reputation as a monetary hawk. "No one knows which version of Warsh will take the stage."

Despite headwinds from energy, geopolitics, and tariffs, the economy and stock market continue to heat up with the AI investment boom, leading many to question why the Fed would consider easing again.

Warsh's rethinking and adjustments may deviate from many expectations.