Warsh debut preview: dot plot may fade, rate hike signals grow

The Fed's quarterly "dot plot" rate forecast may soon lose its last rate-cut signal, and the chart itself could even be scrapped. If that happens, markets will have to judge whether Warsh (Kevin Warsh) is really the inflation hawk he has claimed to be.

The new Fed chair is busy setting out his stance and hearing from staff ahead of his first policy meeting later this month. Any guidance from the policy path will not offer a simple answer.

The explosive growth in AI investment and the surge in energy prices from three months of war in Iran have pushed inflation far above target. Add in the uncertainty inside the Federal Open Market Committee (FOMC), and futures-market sentiment has turned fearful, with the next Fed hike now seen as possible before year-end.

One of the few remaining arguments from the doves in recent months is that the labor market, the other side of the Fed's dual mandate, could crack, and layoffs tied to AI or energy-related production cuts could worsen that. But there is little sign of that now.

Instead, there are signs the job market looks strong and may even be improving. A big rise in April job openings and May private payrolls that increased by 122,000 and beat expectations point that way. The national nonfarm payroll report for May will be released Friday and will test that trend.

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

Beyond any signals Warsh gives at his press conference, markets will be watching closely to see whether any hint in the Fed's earlier statement about a bias toward another cut is removed. At the last rate meeting, three governors already voted to delete that wording, and since then at least one other recently dovish governor, Waller, has joined them.

But the quarterly economic forecasts updated by Fed policymakers, including the "dot plot" that projects rates over the next few years, could become the focus.

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

Remarks from Fed officials since March suggest the expectation of a cut this year is likely to disappear from the dot plot. Whether 2027 will still see a cut, or even a hike as some in the market expect, may have the biggest impact on markets.

Of course, the irony is that Warsh's dislike of so-called forward guidance could lead him to abolish the "dot plot" altogether. He would have many supporters if he did, including his predecessor Powell, who still serves as a Fed governor.

If the outlook for further easing is removed and guidance stops, leaving markets to make their own judgments as new data come in, the rate market in the second half of the year could become even more tense and volatile.

Some investors, of course, still hope the eventual end of the Iran war will put easing back on the table, or that the squeeze from energy prices on real incomes will be enough to curb household demand and rein in other prices.

But many others think the situation has already turned.

The rate-cut plan grinds to a halt

SGH Macro economist Tim Duy says the inflation consequences of higher energy prices now dominate the growth impact, and that as the Fed begins to realize December's final cut was a mistake, views inside the FOMC are shifting rapidly hawkish.

"Fed officials are realizing the risk of inappropriate monetary policy is rising, and they are moving quickly in a hawkish direction to pave the way for hikes," he said.

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

Even with headwinds from energy, geopolitics and tariffs, the economy and stock market have kept heating up on the back of the AI investment boom, and many are asking why the Fed would even consider easing again.

Warsh's rethink and adjustment may diverge from what many expected.