One of the last signals for interest rate cuts within the Federal Reserve's quarterly "dot plot" projections may soon disappear, specifically the so-called "easing dot," and the chart itself could potentially be scrapped entirely. At that point, the market will have to determine whether Kevin Warsh truly aligns with his previously stated reputation as an inflation hawk. If he does, it might come as a surprise to some investors.
The new Fed Chair is busy establishing his stance and gathering input from staff ahead of his first policy meeting later this month. Any guidance he provides on the policy direction is unlikely to offer a straightforward answer.
The remarkable surge in AI-related investment and the spike in energy prices driven by the ongoing three-month conflict involving Iran have pushed inflation well above target levels. Combined with the shifting dynamics within the Federal Open Market Committee, futures markets are growing anxious, anticipating the Fed's next rate hike could come before year-end.
In recent months, one of the few remaining arguments for dovish policymakers has been the potential for cracks in the labor market—the other side of the Fed's dual mandate—which could be exacerbated by AI-related layoffs or energy-driven production cuts. However, there is currently little evidence of such weakness.
Instead, signs point to a robust job market, possibly even strengthening further. A significant rise in job openings in April and a better-than-expected addition of 122,000 private-sector jobs in May support this view. The national non-farm payrolls report for May, due on Friday, will serve as a key test of this trend.
The Fed is not expected to raise rates this month, but it may plant the seeds for future hikes.
Beyond any signals Warsh conveys during his press conference, markets will closely watch whether the Fed removes previous hints of a bias toward further rate cuts from its policy statement. At the last meeting, three governors already voted to eliminate such language, and since then, at least one previously dovish-leaning governor has joined their ranks.
However, the Fed policymakers' quarterly updated economic projections, including the "dot plot" that forecasts interest rate paths over the coming years, are likely to be a focal point.
The current median projection suggests one more rate cut this year and another in 2027.
Various comments from Fed officials since March indicate the expectation for a rate cut this year is likely to be removed from the dot plot. Whether a cut is projected for 2027, or even if a hike is signaled as some in the market expect, could have the most significant market impact.
Ironically, Warsh's known aversion to so-called forward guidance might lead him to abolish the dot plot altogether. He would find support for such a move from many quarters, including his predecessor, who remains a Fed governor.
If the prospect of further easing is removed and explicit guidance is halted, leaving markets to interpret incoming data on their own, the interest rate environment could become more tense and volatile in the second half of the year.
Naturally, some investors still hold hope that an eventual end to the conflict involving Iran could bring easing back onto the agenda, or that the impact of higher energy costs on real incomes will sufficiently dampen household demand to contain other price pressures.
But many others believe the tide has already turned.
SGH Macro economist Tim Duy argues that the inflationary consequences of rising energy prices now outweigh concerns about economic growth, and that sentiment within the FOMC is shifting rapidly as the Fed comes to recognize its final rate cut in December was a misstep.
"Fed officials are increasingly aware of the risk that monetary policy is inappropriate and are pivoting quickly toward a hawkish stance, paving the way for rate hikes," he said.
"The old Warsh would have hiked sooner," he added, referring to Warsh's long-standing reputation as a monetary hawk. "No one knows which version of Warsh will show up."
Despite headwinds from energy, geopolitics, and tariffs, with the economy and stock market continuing to heat up amid the AI investment boom, many are questioning why the Fed would even consider further policy easing.
Warsh's process of re-evaluation and adjustment may well diverge from what many currently anticipate.
Comments