Federal Reserve Chairman Kevin Warsh presided over his first policy meeting, where he signaled a hawkish direction for the central bank, prioritizing price stability and hinting at interest-rate hikes this year. This new direction, characterized by Warsh's statement that "inflation is a choice" and a move away from forward guidance, has led to a significant shift in market expectations, with a tightening campaign now considered a live possibility rather than a tail risk.
Market reactions to Warsh's stance have been immediate and pronounced. The yield on the 2-year Treasury spiked over 16 basis points to above 4.21%, and expectations for an interest rate hike were pulled forward to as soon as October. Stocks pulled back, the bond market came under pressure, and hike odds for the September Fed meeting climbed significantly to 65% while cut odds fell to 2%. Risk assets like gold and cryptocurrencies also saw declines, with gold dropping from $4,400 to $4,240 and Bitcoin losing about 5%.
Inflation data is now under intense scrutiny, particularly the upcoming personal consumption expenditure (PCE) price index for May. Consensus estimates project core PCE, which excludes volatile food and energy prices, to rise 0.37% last month, up from 0.24% in April. The Fed itself raised its core PCE forecast to 3.3% in 2026, up from 2.7% previously, indicating heightened concerns about persistent inflation. Analysts suggest that a monthly core PCE reading above 0.21% would exceed the new Fed forecast, and a rate closer to 0.3% could lead to a meaningful tightening of financial conditions.
While lower oil prices, with WTI falling to around $76.60 per barrel and US gasoline prices slipping below $4.00 per gallon for the first time since March, typically suggest a friendlier inflation trajectory, the May PCE report covers a period before these agreements took effect. Therefore, the energy relief is not expected to be reflected in the upcoming data, forcing the market to interpret the inflation numbers without the previous clarity provided by the Fed's abandoned communication tools.
Adding to the economic landscape, retail sales in May rose a better-than-expected 0.9%, excluding sales at gas stations, further indicating consumer spending remains robust. However, this also contributes to inflation concerns. In the euro area, a key gauge of underlying price pressures was stronger than initially reported, reinforcing the European Central Bank's worries about lingering inflation risks stemming from the conflict in the Middle East.
