Fed Moving Rates Higher?

MACRO FRAME

The US and Iran have agreed to a framework deal to end their conflict, reopen the Strait of Hormuz, and move toward broader negotiations—though major issues (Lebanon conflict, nuclear program) are not fully resolved yet.

STOCK INDEX FUTURES

Equity index futures marked a sharp reversal higher overnight, after stocks fell sharply in an FOMC induced sell-off. After Warsh’s press conference, markets fully priced in a Fed hike by October, triggering a broad risk-off move, the Dow shed 500+ points, the S&P and Nasdaq similarly. Warsh’s comments led investors to fully price in a Fed hike by October, with the repricing weighing on risk assets. This aligns with the bear flattener in Treasuries and the sharp front-end repricing. The overnight reversal came from a separate catalyst entirely: President Trump signing the 14-point US-Iran Memorandum of Understanding at the Palace of Versailles. The Strait of Hormuz is to reopen for commercial traffic within 30 days, while the US hands over other major concessions.

Warsh’s statement explicitly attributed elevated inflation to “supply shocks that have driven price increases in certain sectors, including energy”. The Strait of Hormuz had been near-totally blocked since the conflict began, removing an estimated 14 million barrels per day of global oil supply from the market. With the MOU signed, Brent and WTI both fell over 2% Thursday morning, continuing a decline that began when the deal was first announced June 14 (Brent was at ~$84 then). If oil continues to normalize, it directly undermines the primary inflation driver Warsh cited, which in turn could reduce the probability of the hikes that repriced markets on Wednesday. That’s the bull case embedded in Thursday’s bounce higher.

On the defensive end, recent weakness has highlighted that the rally is concentrated in just a handful of crowded AI and tech names, leaving downside risks tech-related growth, cash‑flow conversion, or capex discipline disappoint.

Watch point: While May’s softer core CPI print reduces the urgency for additional Fed tightening and should be welcomed by equities, core inflation remains above target, suggesting policy will stay restrictive and reinforcing the case for selectively adding some defensive positioning alongside exposure to the ongoing tech‑led momentum.

CURRENCIES

US DOLLAR: The USD index is 0.57% higher at 100.66. The Fed’s dot was more hawkish than expected, leaving markets to reprice the outlook for Fed policy with some expectations of a Fed rate hike as early as September. Nine policymakers expect the Fed Funds rate to move upwards by the end of the year, while median forecasts show PCE inflation expected to climb by around 90 bps from the March projection. While he preliminary US-Iran deal and drop in oil prices have lifted risk appetite and initially led traders to reduce expectations of Fed rate hikes, yesterday’s FOMC meeting altered the outlook for markets. It is likely to take weeks for tanker traffic to resume to pre-war levels, leaving risks to inflation pointed to the upside, offering the dollar support.

Watch point: A durable peace agreement and drop in oil prices is likely to unwind expectations of Fed policy tightening, though Wednesday’s FOMC marked a sharp reversal in recent market dynamics, with the dollar now finding stronger support against foreign currencies.

EURO: The euro is 0.24% lower at $1.1470 as traders digest details of the US-Iran peace agreement and the global central bank outlook following the Fed’s rather hawkish hold, alongside a hold from the Bank of England. While the cease in hostilities lowers the geopolitical risk premium and oil prices, emerging second-round inflation effects from the conflict could impact European Central Bank policy. ECB’s Nagel added that oil supply recovery would take months, delaying any inflation relief for some time. Money markets continue to expect one more rate hike from the ECB this year come October. For the ECB, policy is likely to remain biased upwards, though a continued easing in services inflation could dull some expectations of a move upwards. The euro is likely to benefit from risk-on flows away from the dollar, though increased expectations of Fed tightening, a sharp reversal from earlier dynamics, now offer fresh pressure against the euro.

BRITISH POUND: Sterling fell 0.36% lower to $1.3245 after the Bank of England held rates steady in a 7-2 vote, in line with market expectations. Governor Andrew Bailey’s message was largely: it remains too early to call off the inflation risk. Looking ahead, the bar for further tightening appears high and contingent on renewed energy or expectations, while a sustained easing in inflation and confirmation of a softer labor market would keep the debate focused on how long policy must stay restrictive rather than any tightening.

JAPANESE YEN: The yen is continues to fall against the dollar, now trading closer to 161 yen per dollar, as recent dollar strength further pressures the currency. The outlook between the Fed and Bank of Japan is offering a renewed pressure against the currency as markets seemingly expect more policy action from the Fed than the BoJ. The Bank of Japan’s rate hike offered the yen no support despite rates being at their highest level in 31 years. With policy rates in Japan still deeply negative in real terms, incremental moves are unlikely to deliver a durable yen rebound. Instead, markets are increasingly focused on the broader policy mix: rising long yields alongside a weak currency highlight concerns over Japan’s heavy debt load, while political support for a weaker yen, equity benefits from FX depreciation, and reluctance to tackle the debt overhang suggest any sustained yen strength will require more than rate hikes alone. The market sees a total of 19 bps of tightening by year-end. Intervention risk continues to offer the currency support around the 160 level.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7015. The Reserve Bank of Australia held interest rates steady earlier this week and warned that further tightening could be necessary, though markets have cast doubt on that scenario. In the near-term rate differentials favor the USD, leaving the Aussie exposed to downward pressure. The central bank board noted the economy and consumer demand had slowed, thanks to higher rates, while the housing market had cooled. It also emphasized that inflation was too high and it stood ready to raise rates again if needed. For the RBA, the move gives policymakers further time to assess how earlier rate hikes are effecting the broader economy, essentially keeping its options open for further meetings. A recent mix of softer economic data has led markets to pare back expectations of another rise in the RBA’s policy rate. Still, demand is largely outpacing supply, labor conditions remain tight, leaving the inflation bias pointed upwards. The trimmed mean measure of inflation sits at an annual pace of 3.4%, which in our view is likely to reinforce a tightening bias from the RBA.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

TREASURY FUTURES

Yields are higher at the front end and lower at the long end as the market continues to digest the Fed’s meeting yesterday and hawkish Summary of Economic Projection. Chairman Kevin Warsh used the meeting to signal a sweeping institutional overhaul, abandon conventional forward guidance, and oversee a quarterly projection cycle that pointed firmly toward the possibility of rate hikes later this year. The immediate post-decision move was a textbook bear flattener. The longer end of the curve was largely unmoved, compressing the 2s–10s spread from approximately +39 bps to +29 bps on the session. The move confirms that the market read the June statement as hawkish at the margin. The SEP delivered the most meaningful surprise. Nine of 18 participants now pencil in at least one rate hike by end-2026. The median fed funds rate projection for year-end 2026 moved to 3.8%, up from 3.4% in the March. Median PCE inflation for year-end 2026 was revised to 3.6% from 2.7% in March, a full 90 bps higher in just one quarter. Core PCE followed suit, moving from 2.7% to 3.3%.By characterizing the inflation overshoot as supply-driven rather than demand-driven, Warsh leaves analytical room for yields to eventually ease if the supply shocks dissipate. Money markets are now favorable to a rate hike come September and are fully priced in for a hike by the following meeting in October.

Watch point: The Warsh-led Fed held on rates and signaled broad institutional change. Mainly, markets should expect fewer words from the Fed and less policy signaling, raising near-term rate volatility with incoming data.

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