- A September hike remains our baseline, but we see the July meeting as live. The statement contained the phrase: “The Committee will deliver price stability” which when juxtaposed with an SEP that revised the 2026 core PCE inflation forecast 60bp to 3.3%, the 2027 core forecast to 2.5% and the 2026 U-rate projection 0.1% lower, raises the reasonable question asked by Claire Jones of the FT as to why the committee did not hike at the June meeting. Warsh went on to say in the presser that “the good news is we’ll be meeting in six weeks” and that “we’ve got some work to do on the price stability front”. We think that the market should not weigh this communication with the inertia it applied to the pre-Warsh era and should instead take seriously the message that the next move is a hike, that a hike is likely imminent and the Fed will not continue the market hand-holding exercise of pre-communicating the policy outlook.
- The strategic implications of the June meeting seem quite significant. The Warsh Fed appears to be significantly more activist, which means that policy changes can be enacted more quickly. We see this as a shift from inertial to adaptive policy making. This should reduce the probability that deviations from the mandate become entrenched and a Fed that is ahead of the curve is also afforded the flexibility of being able to reverse policy changes once the risk to the mandate has been addressed. Strong medicine, prescribed in a timely manner, allows the patient to recover more quickly.
- This may, however, represent a real challenge to a forecasting community that has been rewarded over a multi-year period for marking forecasts to futures markets on an ex-post basis. From here we would expect original thought and primary analysis will be the predominant sources of forecasting edge, more closely aligned to how markets trade. We think that Warsh’s observation that market prices contain high value information for the central bank, and that it is important not to pollute that signal with forward guidance, is profoundly important and is a foundational principle of our cross asset macro framework.
- We think the market implications of the meeting are as follows: firstly, our base case is that the market should price 3x25bp hikes into the front end. Over the next two years the Fed’s forecast inflation gap averages 90bp (3.3% ’26 + 2.5% ’27 core PCE forecast vs 2% target), a classic policy prescription implies that policy should be 1.5x the inflation gap above neutral (so 135bp). That suggests that the policy rate should be 4.25-4.50%, implying 3x hikes – assuming neutral is 3%. Our base case is that these hikes come in September, December, and March-27. We think the dollar should benefit from a significant unwind of concerns around Fed independence/commitment to the inflation mandate and relatedly both real and nominal term premium should decline given the credible commitment to addressing the inflation overshoot. This would typically continue to flatten the rates curve. We think it may also mean that implied volatility on short-dated tails increases to reflect an adaptive policy outlook, and it may also reduce the implied volatility on longer dated tails due to improved inflation credibility. For equity markets, a hawkish Fed is a hawkish Fed, but a more proactive Fed is somewhat easier to deal with than a Fed that gets behind the curve because it reduces the tail risk of needing very high rates at some point in the future, as well as allowing policy tightening to be taken back more quickly as mandate deviations are addressed in a timely manner.
Copyright © Citadel Enterprise Americas LLC or one of its affiliates. All rights reserved.
Legal Entities Disseminating this Material: This material is disseminated in the United Kingdom by Citadel Securities (Europe) Limited (“CDGE”) authorized and regulated by the Financial Conduct Authority (“FCA”) (Registered company number: 05462867); in the European Union by Citadel Securities GCS (Ireland) Limited (“CSGI”) and its Paris Branch authorized and regulated by the Central Bank of Ireland (“CBI”) (Registration Number: C173437); in Hong Kong by Citadel Securities (Hong Kong) Limited (“CDHK”) licensed by the Securities and Futures Commission of Hong Kong (“SFC”), in Japan by Citadel Securities Japan Co., Ltd (“CSJC”) registered as a Type 1 financial instruments business operator with the Japan Financial Services Agency (“JFSA”); and in the United States of America by Citadel Securities LLC (“CDRG”) registered with the Securities Exchange Commission (“SEC”), Financial Industry Regulatory Authority (“FINRA”), and Securities Investor Protection Corporation (“SIPC”), Citadel Securities Institutional LLC (“CSIN”) registered with the SEC, FINRA, and SIPC, or Citadel Securities Swap Dealer LLC (“CSSD”) registered with the SEC, Commodities Futures Trading Commission (“CFTC”), and National Futures Association (“NFA”). Unless governing law permits otherwise, you must contact a Citadel Securities entity in your home jurisdiction if you want to use our services in effecting a transaction in any financial instruments or securities, including derivatives.
FOR INSTITUTIONAL USE ONLY; FOR PROFESSIONAL CLIENTS AND ELIGIBLE COUNTERPARTIES ONLY. This material is not intended as and does not constitute investment research. Contents of this material will be strictly limited to non-specific, generic information (i.e. macro events/topics) and are not subject to the Markets in Financial Instruments directive (MiFID II) or FINRA research rules. This material does not constitute an offer, solicitation, invitation, or inducement to purchase, acquire, subscribe to, provide, or sell any financial instrument or otherwise engage in investment activity. Please see additional important disclosures, including disclosures that may be relevant to your country of residence or business at www.citadelsecurities.com/GlobalSalesTrading.
