Early Tuesday, a US naval fleet transited the Strait of Hormuz, escalating regional tensions. However, dovish remarks from the Federal Reserve's third-in-command, John Williams, increased the possibility of a shift towards interest rate cuts by the central bank. This led to a surge and subsequent retreat in the yields of 2-year to 10-year US Treasury bonds, although they still closed significantly higher.
Later during the Asian and European trading sessions, as the US warships passed through without a major armed conflict, global risk appetite improved, causing US Treasury yields to weaken. With Kevin Warsh poised to take office, the three dissenting votes favoring a rate hike at the last Fed meeting presented a significant obstacle for his administration. However, Williams' comments offered a glimmer of hope for potential rate cuts within the year.
Recent reports indicate that Israel and the US are coordinating, including preparations for a potential new strike against Iran, though the current actions are likely more about deterrence than immediate action.
Kevin Warsh's Path to Leading the Fed Kevin Warsh, nominated by Donald Trump, is set to formally assume the role of Federal Reserve Chairman on May 15th. However, his agenda to push for interest rate cuts faces severe challenges from the outset.
A core obstacle for the new chair comes from the remaining Fed Governor, Jerome Powell, whose term is confirmed until January 2028. As a key figure staunchly opposed to aggressive rate cuts, Powell's continued presence is the most significant constraint on Warsh's accommodative policy plans.
Powell revealed that he had originally planned to step down completely. However, due to sustained legal pressure from the Trump administration—including a Justice Department investigation into alleged cost overruns in the Fed building renovation—he decided to remain until these matters are "transparently and finally resolved."
This situation, combined with the impending Supreme Court ruling on Trump's dismissal of Governor Lisa Cook, has plunged the Fed into a rare predicament of political and legal intervention in the history of the US central bank.
Multiple Challenges Awaiting Warsh Although Warsh has secured the top decision-making authority at the Fed, the real battle is just beginning.
The primary challenge stems from a severe division within the Federal Open Market Committee (FOMC). In the latest policy meeting, the decision to maintain the interest rate in the 3.5%-3.75% range passed with 8 votes in favor and 4 against, marking the highest number of dissents since October 1992. Three of those dissenting votes explicitly supported a rate hike.
More棘手的是, hawkish forces are on the rise. The Presidents of the Cleveland, Minneapolis, and Dallas Federal Reserve Banks, while supporting maintaining the current rate, clearly refused to signal any future easing.
Furthermore, the lone vote for a 25-basis-point cut came from Trump-appointed Governor Stephen Milan. The potential risk of his absence—should Powell's departure require Senate confirmation for a replacement—further weakens the dovish faction.
An analyst at Portfolio Personal Investors stated bluntly, "Even if Warsh leans towards cutting rates, gathering the necessary seven supporting votes in the short term is almost unfeasible."
More严峻的是, if a majority of FOMC members advocate for a rate hike and Warsh casts a dissenting vote against the trend, he would be caught between the institution's need for independence and his political appointment commitments. A public dissent by the chair has occurred only three times in Fed history and could severely impact his policy execution ability and market credibility.
Latest Fed Developments: Hawkish Leanings and Market Reaction The Fed's "third-in-command," New York Fed President John Williams, stated publicly that the current monetary policy stance of the US Federal Reserve is in a good position to handle the high economic uncertainty caused by the war in the Middle East.
He also noted that the long-term federal funds rate should be around 3%, and once the current short-term surge in inflation is effectively alleviated, the Fed could refocus on lowering interest rates.
This statement was Williams' first public response following the Fed's decision last week to hold rates steady, revealing a policy approach of watchful waiting with options kept open amid complex circumstances.
Neil Dutta, Head of Economic Research at Renaissance Macro Research, pointed out, "The threshold for a rate hike last week was already lowered. Although the process might be prolonged, the adjustments in the FOMC policy statement and the Summary of Economic Projections are clear—hawkish forces are dominating the narrative."
Market reaction followed swiftly: the CME FedWatch Tool shows the probability of a rate cut at any of the remaining six policy meetings in 2026 is below 7%, as traders have significantly increased expectations for a rate hike within the year.
Meanwhile, asset markets showed clear divergence: although the S&P 500 index closed at a record high on Friday, it began to pull back on Monday, down 0.4%.
Conversely, US Treasury yields moved higher across the board. The 10-year yield rose 6 basis points to 4.44%, the 5-year yield climbed 7 basis points to 4.10%, and the 2-year yield surged 8 basis points to 3.97%.
Rising oil prices exacerbated market volatility. West Texas Intermediate crude oil prices briefly surpassed $106 per barrel, triggered by an Iranian drone attack on oil facilities in Fujairah, UAE. As this area is a hub for bypassing Hormuz Strait shipping, the heightened tensions further amplified energy inflation risks.
Institutional Inflation Outlook: Mild Stagflation Risks Emerge The bond market is sending a clear warning signal of "mild stagflation."
Nicholas Colas, Co-founder of DataTrek Research, noted that the inflation expectations implied by five-year US Treasury breakevens are approaching 2.7%, near the 2023 high, while inflation-adjusted real rates are trending downwards.
This divergence suggests the US economy faces dual pressures of "rising inflation and slowing growth." On one hand, oil price increases sparked by Middle East conflicts are beginning to transmit to the US economy, pushing up price pressures. On the other hand, below-average real rates suggest economic growth will be slower than in the past three years.
Colas warned that this environment means "the Fed must raise rates this year to maintain the credibility of its 2.0% inflation target, otherwise it risks falling behind the curve."
Notably, a clear divergence exists between the stock and bond markets. Equity investors are focusing on corporate profit margin growth, while the bond market has begun pricing in rising inflation risks. This split highlights the market's digestion process in the early stages of potential stagflation.
Interest Rate Direction and its Link to the Dollar Index The policy博弈 at the Fed directly impacts the US Dollar Index. The three dissenting votes favoring a hike on April 29th directly pushed the Dollar Index to a recent high. Similarly, Williams' dovish comments led to an immediate pullback in the index.
Currently, the Dollar Index is influenced not only by Fed policy expectations but also by geopolitical risk aversion and some capital flows away from the Euro.
The withdrawal of US troops from Europe, coupled with tariffs on Europe, has prompted short-term避险 capital to sell Euros and flow into US dollars. Simultaneously, while the long-term effect of US warships opening new routes through the Strait of Hormuz is to weaken避险 sentiment, the marginal increase in the risk of an accidental clash has led some capital to buy dollars for短期避险.
As of 20:38 Beijing Time, the US Dollar Index was reported at 98.48.
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