After Abolishing Forward Guidance, Warsh May Raise Rates Sooner Than Market Expects

The probability of a rate hike before September is close to 100%—the earlier the action, the lower the cost of taming the market, and the fewer rate hikes may ultimately be needed.

Written by: Huatai Ruis, Wall Street Insights

Core Viewpoints

After taking office, the new Federal Reserve Chairman Kevin Warsh has seen financial markets shift their pricing of his policy stance from a previously dovish rate cut to a more hawkish short-term position. However, as the July FOMC meeting approaches, market expectations for the Fed's next policy move have become extremely polarized. With Warsh abolishing forward guidance, market pricing has become more challenging, and the focus of the game between Warsh and the market is bound to shift from “listening to his words” to “watching his actions.” By analyzing the experiences of previous Fed chair transitions, the current macroeconomic environment, and Warsh's goal of gaining credibility, we have brought forward our prediction for the Fed's rate hikes—we expect the probability of a rate hike in July to be slightly above 50%, higher than the current market expectation of 40%, and under baseline conditions, the probability of a rate hike before September is close to 100%. From the perspective of the new chairman and the market game, the comprehensive cost of a rate hike in July may be lower.

1. Warsh's Short-Term Primary Goal is to Restore the Fed's Credibility, "Make the Dollar Great Again"

In his FOMC “debut” on June 17 and several subsequent speeches, Warsh emphasized his determination to reform the Fed through a series of policy changes. Warsh indicated that the previous market expectations were more hawkish and focused on long-term reforms. Two weeks after Warsh's FOMC debut, market pricing for rate hikes over the next 12 months rose by 15 basis points, and the credibility of the dollar and U.S. Treasuries rebounded in the short term: evidenced by a temporary drop in the 10-year Treasury yield and inflation expectations, a decline in long-term rates, a compression of the yield curve, and a short-term weakening of gold and the Swiss franc against the dollar.

From a short-term forecasting perspective, Warsh's two key statements are critical variables: ① zero tolerance for excessive inflation; ② abolishing forward guidance. Anchoring long-term bond yields is more important than preventing short-term volatility. In the medium to long term, Warsh advocates reducing the Fed's balance sheet and strengthening dollar liquidity management to restore the dollar's credibility as a reserve currency.

2. Previous Fed Chairmen Have All Experienced a Period of Market Adaptation and "Testing" After Taking Office

In the early stages of their tenure, previous Fed chairmen have mostly gone through a period of increased market volatility, especially in the bond market—this can be understood as the market “adapting” to the new chairman or the new chairman gaining the market's trust. We reviewed the experiences of the past eight Fed transitions and conducted scenario analysis based on the current situation. If nominal growth accelerates but the policy is dovish, the Fed/dollar “credibility indicators” may weaken across the board; conversely, if growth accelerates but the policy is hawkish, stock market enthusiasm may decline but still have fundamental support, strengthening the Fed/dollar credibility indicators, similar to the situations during the early tenures of Volcker and Greenspan.

3. The Highly Uncertain July FOMC Meeting and Its Scenario Analysis

Before the July FOMC meeting, market expectations have fluctuated again: rate hike expectations initially suppressed and then surged with the release of inflation and employment data and the escalation of U.S.-Iran conflicts; at the same time, as anxiety in the market rises after the abolition of forward guidance, the Fed's credibility indicators have weakened again, and long-term U.S. Treasury yields have risen again.

Overall, an early rate hike may better serve Warsh's short-term primary goal, while a delayed rate hike may come at a higher cost. First, from a game theory perspective, an “unexpected” choice is more conducive to the market breaking its “dependency on forward guidance.” Second, from the perspective of monetary policy credibility, leading or synchronizing with the curve for rate hikes is more beneficial in lowering risk premiums, meaning that raising short-term rates helps to lower long-term rates, especially in an environment of unstable inflation expectations. If there is no rate hike in July, and Warsh has strictly implemented the “new paradigm” of abolishing forward guidance, then the bond market may start pricing Warsh's “bluff,” even tentatively pushing for a loosening of financial conditions, forcing a rate hike in September, and potentially increasing the required magnitude of the hike; however, if there is a rate hike in July, its main intention may be to establish credibility rather than signal an impending series of rate hikes.

In summary, we have brought forward our prediction for the timing of the Fed's rate hikes from two hikes in the first half of 2027 to 1-2 hikes in the second half of this year, with a total of two hikes by mid-next year (including this year). The main risks we foresee are: ① Warsh ultimately chooses to “bluff,” allowing inflation expectations to rise; ② the AI boom “comes to a sudden halt,” leading to a significant correction in growth expectations and risk asset prices, causing economic growth to naturally return to trend levels (or even lower).

In the medium to long term, the structural contradictions of U.S. Treasury credibility and fiscal sustainability cannot be solved solely by the Fed.

This content is provided for general informational purposes only and doesn't constitute financial, investment, legal, or tax advice. Any events, rewards, online promotions, or related information mentioned herein should not be considered a recommendation, solicitation, or invitation to purchase, sell, trade, or otherwise deal in any crypto assets. Crypto assets are highly volatile and may result in loss. The availability of WEEX services, products, and related events may vary by region. You are responsible for ensuring that your participation is in accordance with applicable local laws and regulations.