First the Fed dot then the guidance, and finally a hike. Mike Dolan

Federal Reserve quarterly "dot-plot" rate forecasts could soon lose the last projected rate reduction, the so called easing dot. The plot itself may disappear altogether. Markets would then have to determine if Kevin Warsh was really the inflation-hawk he claimed to be. It might still be a surprise to some investors if he's right.

Before his first policy meeting, the new Fed chairman is busy setting up his stall. He consults his staff and gets ready for his first policy session. The guidance he receives on policy direction is not going to be easy.

The three-month-long war in Iran and the soaring energy prices have driven inflation well above target. The Fed's policymaking committee is changing, which has caused the futures market to price the Fed's next rate increase as being up by the end of the year.

In recent months, one of the few arguments that the doves have used is that there may be cracks appearing in the labor markets - the opposite side of the Fed’s dual mandate. These could possibly be exaggerated due to AI-related job losses or corporate cuts related to energy. It's not yet clear.

The labor market appears to be robust and may even be strengthening. If taken at face-value, the sharp increase in April's job openings as well as May's 122,000 job gains above forecasts point this way. The May national employment report will be released on Friday, and it will test this picture.

The Fed is not planning to increase rates this month but may start to plant the seeds.

Markets will be focused on the removal of any language from prior Fed statements that indicates a bias towards ease. Last time, three policymakers voted against it, and since then, at least one dovish member of the board, Christopher Waller has joined them.

The Fed's quarterly update on economic projections and the "dot chart" showing where the policymakers see interest rates in the coming years may be the most interesting.

The median view for this year is another cut and another in 2027.

Fed officials have been voicing their opinions since March, and it appears that the projected reduction for this year is unlikely to be implemented. The biggest impact on the market may be if 2027 follows suit, or even coincides with market prices for a rise.

Irony of ironies, Warsh may try to scrape the "dot plot" entirely due to his dislike for forward guidance. Jerome Powell, his predecessor and still on the board, would be a great supporter of this.

The second half of this year could be more volatile and edgy as the market is left to decide what it wants based on the data that comes in.

Some investors are still holding out hope that the end of the Iran War will bring an easing back to the forefront, or that the real income effect of the energy squeeze on household demand will be enough to hold other prices in check.

Many others, however, feel that the worm is turning.

RATE CUTTING EXIT STAGE LEFT

SGH Macroeconomic Tim Duy believes that the inflationary effects of higher energy costs now dominate the growth impact and that positions are changing rapidly within the Fed’s policymaking Council as it begins seeing its last reduction in December as an mistake.

He said that Fed speakers were rapidly moving in a more hawkish direction, recognizing the growing risk of a bad monetary policy. This was setting the stage for an interest rate increase.

He added that "the old Warsh" would have brought forward rate hikes, referring to Warsh's reputation as a monetary wary. This was even though he used softer words when he sought a position with a president who preferred lower rates.

No one knows who Warsh will appear on stage.

Warsh has hired Paul Winfree, the former Heritage Foundation economist and budget director of President Donald Trump to be one of his two advisors as he transitions into the chair.

Winfree was credited as the author of the Fed chapter in the Project 2025 conservative electoral manifesto of 2023. He had a list of reforms, which included removing the Fed’s maximum employment mandate, and focusing solely the central bank on inflation.

This would be a matter for the Congress, of course.

Warsh's view on the current situation could be more dovish than many thought, depending on who he listens to. The president has said that he will allow him to do what he wants.

Many question why the Fed is even considering easing again, as the economy and stock market are booming on this AI investment boom, despite headwinds such as energy, geopolitics, and tariffs.

Goldman Sachs' overall U.S. Financial Conditions Index has dropped to its lowest level in four years, despite recent tightening of the borrowing markets. Citi's U.S. Economic Surprise Index, meanwhile, is at its highest level in three years.

Jason Thomas, Carlyle's strategist, recalled the Fed's mistake of cutting rates during the dotcom boom in the late 1990s. "Rate reductions delivered during a concentrated capex?boom tends to be far more stimulating than rate reductions arriving under?other circumstances."

Thomas compared the scale of computing capital expenditure now to the dotcom period and noted that real short-term interest rates are now more than 300 basis point lower than they were then.

He concluded that "it's past time to abandon endemic easing."

Warsh's rethinking and reset might not be what many thought.

The opinions expressed are those of Mike Dolan a columnist at. This column is great! Open Interest (ROI) is your new essential source of global financial commentary. Follow ROI on LinkedIn and X. Listen to the Morning Bid podcast daily on Apple, Spotify or the app. Subscribe to the Morning Bid podcast and hear journalists discussing the latest news in finance and markets seven days a weeks.

(source: Reuters)