Wednesday’s First Warsh FOMC meeting will be pivotal for markets, not because there is an expected change of policy. It’s the first meeting to be presided over by a new Fed chair in eight years and could bring important shifts in how the central bank communicates with markets. For that reason, traders are bracing for a potentially volatile aftermath and a shift in direction of the dollar and gold.
The consensus is near-universal that the FOMC will keep rates unchanged. The issue is what the committee signals for the rate path for the rest of the year. Going into the meeting, futures are pricing in around 60% odds that the Fed will hike by the end of the year. But those chances are falling since the tentative deal to end hostilities in the Middle East and reopen the Strait of Hormuz. FOMC officials will have to decide on several key policy matters with this major issue still uncertain, and that could lead to some hedging in the FOMC statement.
The Fed’s Hormuz Problem
There is plenty of data to support a push for raising rates. Three months of solid job growth have meant the focus is now fully on inflation. And last week, inflation rose to a three-year high, driven primarily by higher energy prices. The core rate ticked up, suggesting that some of those higher energy costs are being passed through to the broader economy. Other central banks have hiked to pre-empt a rise in inflation. The last time there was a major energy crisis, the Fed was roundly criticised for saying increasing consumer prices were “temporary”.
However, it might be true that this time around the effect is temporary, if crude prices drop back to where they were in February before the war started. Back then, the Fed itself was predicting a rate cut this year. So, if the Fed signals more hawkishness at this meeting and then crude prices drop just two days later as the Strait of Hormuz opens, it could be seen as a bad decision.
Reducing Forward Guidance
To complicate matters, Warsh is known for wanting to shift the Fed’s focus away from detailed forward projections toward a more data-driven approach. He’s harshly criticised the dot-plot matrix, which is due for an update at the upcoming meeting. The last time it was released in March, it showed projections for one rate cut. The question is whether the dot plot will be updated to show no rate cuts, or whether Warsh will largely discount it.
Markets will also be paying close attention to the Chair’s tone during the press conference. Appointed by Trump, Warsh is expected to be dovish, but he has also made harsh comments about inflation and largely ignored the jobs market. This suggests he could come across as more hawkish than the market is anticipating.
The Key Language Points
The last meeting had an extraordinary number of dissents over the language in the FOMC policy statement. At the time, the statement left an easing bias despite rising inflation. The market widely anticipates that the Fed will shift that bias to neutral. Not doing so will be seen as very dovish in the current circumstances.
Markets are likely to fluctuate quite a bit in the aftermath of the meeting as they compare Warsh’s comments with Powell’s and try to accommodate for the difference in language choice. However, the main takeaway is likely to be whether Warsh puts the emphasis on the economy (which will be seen as dovish) or inflation (seen as hawkish).
