Hawkish stance from Warsh’s FOMC surprises markets

Highlights: The Fed kept rates unchanged at 3.50 per cent–3.75 per cent in a unanimous 12–0 vote. But Kevin Warsh’s first meeting as Fed Chair delivered a clear shift in tone, with a stronger emphasis on inflation risks and less reliance on forward guidance. We continue to think that the FOMC will hold the federal funds target range steady through 2026 and 2027, in line with most Fed members. But the more hawkish tone supports our view that USD should range trade rather than weaken, and bond investors are best served by clipping coupons. While strong earnings growth should continue to drive equities higher in spite of the more hawkish tone, we like to add hedge funds and infrastructure to diversify.

• The more hawkish tone supported USD and caused some upward pressure on short-dated bond yields. But the Fed’s clear focus on fighting inflation helped bring down longer-dated bond yields
• In spite of the mild US equity weakness overnight, we maintain our bullish view, supported by resilient consumer spending, strong corporate balance sheets and continued investment in AI and infrastructure
• In fixed income, we remain focused on income over capital gains, as prospects for rate cuts have declined even further. We prefer Investment Grade credit and select Emerging Market debt, where still-attractive yields and limited near-term spread-widening catalysts support carry opportunities
• The FOMC is more divided than the market had anticipated, and the US dollar has capitalised on the resulting rate repricing. For now, USD is likely to remain supported, and we believe it has already made its low for 2026
• The updated dot plot turned more hawkish, with 9 of 18 officials now projecting at least one rate hike in 2026. The median 2026 Fed funds projection rose to 3.8 per cent, up from 3.4 per cent in March, shifting the debate from potential cuts to whether a hike may be needed
• The Summary of Economic Projections showed a tougher inflation outlook, with 2026 PCE inflation revised up to 3.6 per cent from 2.7 per cent and core PCE inflation revised up to 3.3 per cent from 2.7 per cent
• Warsh downplayed the precision of the dot plot, did not submit his own projection, and said that the 2 per cent inflation target is not up for review until the Fed has re-established credibility in achieving it
• Undoubtedly the Fed reaction at the first Warsh FOMC meeting was more hawkish than anticipated. There is a chance that the Fed can look through the transitory inflation if the peace treaty with Iran holds. However, if the peace treaty does not hold, there is a rising risk that energy prices will remain elevated, creating further upside risk to inflation, a further backup in market interest rates, and some volatility for equity markets across the world. Therefore, diversification remains key