Although Warsh released unexpected hawkish signals at his first FOMC meeting, Goldman Sachs, Morgan Stanley, HSBC, UBS, and Deutsche Bank have not included interest rate hikes in their baseline scenarios. Institutions generally believe that the pro-rate hike camp within the Federal Reserve has clearly grown, leading to increased policy uncertainty in the future, but maintaining the current stance remains the most likely path before inflation further deteriorates or the labor market remains excessively hot.

Written by: Bu Shuqing

Source: Wall Street Insight

The new Chairman of the Federal Reserve, Kevin Warsh, made a rapid and distinct personal imprint on the Federal Reserve by significantly compressing the policy statement, abandoning forward guidance, and refusing to submit rate forecast dot plots at the first Federal Open Market Committee (FOMC) meeting he chaired.

The biggest surprise from the meeting came from the Summary of Economic Projections (SEP): among the 18 committee members who submitted forecasts, 9 expect at least one interest rate hike this year, forming a split with the other 9 who expect rates to remain unchanged or to decrease.

Market reactions were evidently hawkish: the market pricing for the federal funds rate at the end of 2026 rose about 20 basis points in total after the statement and press conference, the US dollar strengthened, and the US treasury yield curve exhibited a twisted flattening.

Despite this, according to the Wind trading desk, major institutions such as Goldman Sachs, Morgan Stanley, HSBC, UBS, and Deutsche Bank all maintained a baseline forecast of no rate hikes this year.

Institutions generally believe that the pro-rate hike group within the Federal Reserve has clearly grown, leading to increased policy uncertainty in the future, but maintaining the current stance remains the most likely path before inflation further deteriorates or the labor market remains excessively hot. At the same time, major banks have unanimously raised their assessment of rate hike risks, believing that Warsh's push for a reassessment of the policy framework and communication mechanism is reshaping market perceptions of the Federal Reserve's reaction function.

Institutions Maintain Status Quo Baseline Forecasts, But Raise Rate Hike Risks

Despite the meeting sending clear hawkish signals, Wall Street's major banks did not include rate hikes in their baseline scenarios.

Goldman Sachs' report noted that the risk of rate hikes has increased this year, but the baseline scenario remains unchanged rates.

The bank pointed out that if subsequent inflation data becomes unsettling and employment growth remains robust, a majority of committee members might support a rate hike; however, the bank believes that among the 12 voting members, most still prefer to keep rates unchanged, and if geopolitical developments such as the Iran deal or the reopening of the Strait of Hormuz are confirmed, it will quickly eliminate the primary sources of upward inflation risks, making the current dot plot forecasts potentially obsolete.

Morgan Stanley's report maintained its forecast of holding rates steady this year and expects rate cuts to begin in March and June of next year, emphasizing that this is a "very close judgment"—if oil prices feed into core inflation or if the labor market tightens further, the Federal Reserve will not lower rates.

HSBC's report extended the unchanged rate forecast into 2026 and 2027, while pointing out that the hawkish SEP and a more stringent inflation narrative increase the risks of further upward pressure on short-term rates and believe that the dollar may have already bottomed out in 2026.

Deutsche Bank's report noted that a Federal Reserve that does not rely on forward guidance may be more flexible in its actions, creating conditions for rate hikes in the upcoming meetings; however, the hawkish signals today, combined with decreased transparency, may lead to significantly tighter financial conditions, limiting the space for recent rate hikes.

Dot Plot Split, Hawkishness Exceeds Expectations

The June FOMC meeting passed unanimously with a vote of 12 to 0, maintaining the federal funds rate target range at 3.50% to 3.75%. However, the core focus of the meeting was the significant hawkish turn in economic forecasts.

This time, 9 committee members expect rate hikes in 2026, far exceeding the bank's previous expectation of 3 members. Since Warsh did not submit dot plots, a balance was formed among the 18 forecasts with a split of 9 to 9—9 expected at least one rate hike, of which 5 predicted a hike of 50 basis points or more, and 1 expected a hike of 75 basis points; 8 anticipated unchanged rates, with 1 still predicting a rate cut.

The upward revision of inflation forecasts was also significant. The median forecast for PCE inflation at the end of 2026 was significantly raised from 2.7% to 3.6%, and the core PCE inflation forecast was revised from 2.7% to 3.3%. Deutsche Bank pointed out that almost all committee members believe the inflation risk is tilted to the upside. At the same time, the median forecast for the actual GDP growth rate in 2026 was slightly revised down to 2.2%, and the unemployment rate forecast edged down to 4.3%.

Morgan Stanley's report noted that their own forecast for core PCE inflation in 2026 is 3.0%, significantly lower than the Federal Reserve's median, which is a key basis for maintaining their unchanged forecast this year.

Warsh Press Conference: Hawkish Tone, Refusal of Forward Guidance

Warsh's first press conference had a distinctly hawkish tone, but he deliberately avoided any specific policy path guidance.

On the issue of inflation, Warsh repeatedly emphasized that the Federal Reserve "has the ability and commitment to achieve 2% price stability," and reiterated that "inflation is a choice." According to the Deutsche Bank report, he mentioned "price stability" as many as 12 times during the press conference, and the last sentence of the policy statement was simplified to: "The committee will achieve price stability."

Regarding the labor market, Warsh did not mention any downside risks, stating that employment data "is developing in a good direction," and noted that "robust productivity-driven growth is not what we worry about, but what we welcome."

According to the UBS report, he also stated that the current policy stance is somewhat restrictive in certain areas (such as housing), but it is difficult to describe the same in relation to financial markets and attributed this "imbalance" phenomenon to differences in the transmission mechanisms of rate tools and balance sheet tools.

On the issue of forward guidance, Warsh explicitly stated that he has "abandoned forward guidance" and believes that "financial markets perform best when reacting to actual data rather than how the Federal Reserve will react to the data."

He also revealed that he did not submit any dot plot forecasts and holds a reserved attitude towards the value of the SEP framework. According to the UBS report, he used the term "working group" as many as 29 times during the press conference.

Five Working Groups Launched, Systematic Reassessment of Policy Framework

Warsh announced the establishment of five working groups covering: 1) Federal Reserve communication mechanisms; 2) balance sheet; 3) the use and dependence on existing data sources; 4) productivity and employment in a transformative era; 5) inflation framework.

Warsh stated that the working groups will start "in the coming weeks," and most working groups are expected to reach conclusions by the end of the year, with members including internal Federal Reserve economists and external experts.

Regarding communication mechanisms, Warsh expressed skepticism about the value of the SEP and hinted that the frequency of future press conferences may be adjusted—"Press conferences are useful, but when you convene one, you need to ensure there is something important to say." Morgan Stanley's report noted that if the chairman himself does not endorse the SEP process, the sustainability of that framework is in doubt, but other committee members will continue to submit forecasts until the working group reaches conclusions.

On the balance sheet issue, HSBC's report noted that the wording in the policy statement regarding reserve management purchases was changed to "conducted at an appropriate time," indicating a more cautious attitude toward expanding the SOMA scale and leaving room for future resumption of balance sheet reduction.

Concerning the inflation framework, Warsh clearly stated that there will be no reassessment of the 2% inflation target itself until the Federal Reserve re-establishes its ability to achieve the 2% target.