Warsh debut preview: Dot plot may fade, rate hike signals emerge

The Fed's quarterly "dot plot" of rate projections may soon lose its last rate-cut signal, or even the entire chart itself could be scrapped. Then the market will have to judge if new Fed Chair Kevin Warsh is truly an inflation hawk as he has previously claimed.

The new Fed chair is busy taking a stance and listening to staff ahead of his first policy meeting later this month. With no simple clues on policy direction, market interpretation of his debut will be especially sensitive.

The stunning growth in AI investment and the energy price surge from the three-month Iran war have pushed inflation well above target. Combined with uncertainty within the FOMC, futures markets are tense, expecting the next Fed rate hike before year-end.

In recent months, one of the few remaining arguments for doves was that the labor market (the other side of the Fed's dual mandate) might show cracks, exacerbated by AI-related layoffs or energy-related corporate cutbacks. But there is little sign of that yet.

Instead, signs point to a robust job market that may even be improving. A large jump in job openings in April and private sector job gains of 122,000 in May, exceeding expectations, support this. The national nonfarm payrolls report for May, out Friday, will test this trend.

The Fed won't hike this month, but could plant seeds for a hike. Besides any signals from Warsh's press conference, markets will watch closely whether the statement's hint of an easing bias is removed. At the last meeting, three governors voted to remove that language, and since then at least one recently dovish Fed governor (Waller) has joined them.

But the Fed policymakers' quarterly updated economic projections, including the "dot plot" forecasting future rate paths, could be the focus.

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

Various statements from Fed officials since March suggest this year's rate cut expectation will likely vanish from the dot plot. Whether the 2027 projection remains a cut, or even shifts to a hike as markets expect, may have the biggest market impact.

Of course, the irony is that Warsh's distaste for so-called forward guidance likely leads him to abolish the dot plot altogether. He would have plenty of support — including from his predecessor Powell, who still serves as a Fed governor.

If the prospect of further easing is eliminated and guidance stopped, leaving the market to judge based on new data, rate markets could become more tense and volatile in the second half.

Of course, some investors still hope that an end to the Iran war will bring easing back on the table, or that the impact of energy tightening on real incomes will be enough to suppress household demand and thus control other prices. But many see the tide as turned.

Rate cut plans halted

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

"Fed officials recognize the increasing risk of inappropriate monetary policy and are quickly 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 like energy, geopolitics, and tariffs, the economy and stock market continue to heat up with the AI investment boom, raising questions about why the Fed would even consider loosening policy again. Warsh's rethinking and adjustments may differ from many expectations.