Bond traders were caught off guard by the hawkish tone of new Federal Reserve Chair Kevin Warsh's first Federal Open Market Committee (FOMC) meeting. Many had anticipated dovish signals and a potential rate cut, especially given the recent dip in oil prices following the US-Iran peace deal. However, Warsh emphasized the Fed's commitment to returning inflation to its 2% target, leading to a shift in market expectations.
The unexpected hawkishness from Warsh's Fed debut came despite significant declines in oil prices. Brent crude fell 7.7% and West Texas Intermediate (WTI) dropped 10% in the past week after the US and Iran signed a memorandum of understanding on June 17, reopening the Strait of Hormuz. This agreement, which also involves staging sanctions removal, marked the largest single-week decline in oil since spring 2025. Typically, such a drop in oil prices would suggest disinflationary pressures and potentially lead to bond market rallies and expectations of Fed rate cuts.
However, the bond market did not react as expected to the lower oil prices. The 10-year Treasury yield held steady at 4.46% on June 18, and the 2-year yield sat at 4.19%. The Fed's signaling indicates that while energy prices are part of the headline inflation number, services inflation, driven by a tight labor market and wage pressures, is the key policy concern. Services CPI at 4.7% versus 3.5% is what will influence the Fed, not oil moving from $87 to $80 a barrel. This suggests the Fed will maintain restrictive policy until services inflation slows, regardless of fluctuations in oil prices.
Nine out of eighteen Fed officials now project rate hikes, with only one expecting a cut. The median dot plot for 2026 moved from 3.4% to 3.8%. This stance has led to a surge in the Bloomberg Dollar Spot Index, nearing its 2026 high, as markets price in higher interest rates. The widening CCC-to-BB high-yield spread ratio to 6.0 times, the widest in over twelve years, also reflects market adjustments to this hawkish outlook, with investors now keenly watching services inflation figures for future signals.
