Warsh Holds the Line: Dot Plot Shifts Higher, Two Hikes Priced

Kevin Warsh's first FOMC statement as chair carried just three points. Policy remained unchanged. The Fed repeated its commitment to maintaining ample reserves. A third point, the pledge to deliver price stability, got the most attention during the press conference. Warsh refused to speculate on the future path. He instead repeated the committee's commitment to bringing inflation down to 2%.

The dot plot shifted firmly toward a hiking bias. One participant called for a rate cut this year. Eight wanted no change. Nine projected one to three hikes. Median dots for 2027 rose 50 basis points, and the 2028 median rose 25. The core PCE inflation forecast for 2026 was revised to 3.3% from 2.7%. GDP and unemployment forecasts barely moved. The committee saw risks around growth and labour as balanced, a change from an earlier tilt toward weaker conditions. Seventeen of 18 participants saw core inflation risks skewed to the upside.

Warsh announced five task forces to review the Fed's communications, balance sheet policy, data sources, productivity, and inflation framework. He did not say whether the dot plot would continue. The task forces are expected to deliver recommendations by year-end.

Treasury yields moved higher and the curve flattened. Markets repriced the terminal rate up 17 basis points and now price nearly two full rate hikes over the next year. The front end saw a sharp adjustment. July now carries 8 basis points of tightening. September is pricing a cumulative 20 basis points.

AlphaScala's forecast calls for two rate hikes in December and March. Risks are skewed toward an earlier start in September if data keeps beating expectations, the team said. The Fed is expected to continue expanding its balance sheet with T-bill purchases at roughly $10 billion a month.

AlphaScala's recommendation to pay the 2-year SOFR-ESTR spread is 18 basis points in the money. The structural case remains sound. The tactical risk-reward is now less attractive.

The expectation of tighter policy drove breakeven inflation expectations lower. Tighter financial conditions are set to weigh on growth, AlphaScala analysts said. Equities fell and cyclical currencies underperformed as markets repriced the rate path. EUR/USD broke below 1.15. AlphaScala maintains a below-consensus 12-month forecast of 1.12. The team's recommendations to go long the dollar versus both the Swedish krona and Norwegian krone have performed well. A trailing stop-profit has been introduced on the USD/NOK trade to protect gains.