Warsh's Debut Preview: Dot Plot May Fade, Rate Hike Signals Emerge

The Fed's quarterly "dot plot" interest rate projection may soon lose its last rate-cut signal, or even be abolished entirely. At that point, markets will have to judge whether Kevin Warsh is truly the inflation hawk he has claimed to be. If so, it might surprise some investors.

The new Fed Chair is busy staking out positions and consulting staff ahead of his first policy meeting later this month. Any guidance he offers on the policy path will not yield a simple answer.

The stunning growth in artificial intelligence (AI) investment and the energy price spike from the three-month Iran war have pushed inflation well above target. Combined with divisions within the FOMC, futures markets are jittery, expecting the Fed's next rate move could be a hike before year-end.

In recent months, one of the few arguments the doves had left was that the labor market (the other half of the Fed's dual mandate) might crack, possibly worsened by AI-related layoffs or energy-related corporate cutbacks. But there is almost no sign of that yet.

Instead, the job market appears strong and may even be improving. April's big jump in job openings and May's private sector payroll beat (adding 122,000 jobs) both point in that direction. The May national nonfarm payrolls report on Friday will test this trend.

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

Besides any signals from Warsh in the press conference, markets will closely watch whether the previous Fed statement's hint of another bias to cut is removed. Three governors voted to delete that language at the last meeting, and since then, at least one previously dovish governor (Waller) has joined them.

But the quarterly Summary of Economic Projections (SEP), including the dot plot projecting rate paths over several years, could be the focal point.

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

Statements from Fed officials since March suggest this year's rate cut projection is likely to disappear from the dot plot. Whether 2027 sees a cut, or even a hike as markets expect, may cause the biggest shock.

Of course, the irony is that Warsh's disdain for so-called forward guidance may prompt him to abolish the dot plot outright. He would have plenty of support for that – including from his predecessor Powell, who remains a Fed governor.

If further easing is ruled out and guidance is halted, leaving markets to judge based solely on incoming data, the rate market could become more tense and volatile in the second half.

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

But many see the situation as having turned a corner.

Rate Cut Plans Halted Abruptly

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

"Fed officials are increasingly aware of the risk of inappropriate monetary policy and are rapidly turning hawkish, paving the way for rate hikes," he said.

"The old Warsh would have raised rates early," he added, referring to Warsh's long-standing 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 even consider easing again.

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