When Kevin Warsh took the reins at the Federal Reserve in May, markets widely expected a dovish tilt. Warsh had spent months signalling sympathy for lower rates, and traders had entered 2026 pricing in a steady path of cuts, though the Iran-driven oil shock had already begun eroding that view by the time of his first meeting. His first meeting as chair delivered the opposite: a sharply hawkish surprise that has since pushed investors to price in the Fed's first rate hike since the 2022–23 tightening cycle.

The Federal Open Market Committee left its benchmark rate unchanged at 3.50–3.75 per cent at that June 16-17 meeting, the fourth consecutive hold and a decision markets had fully anticipated. What caught Wall Street off guard was everything else in the announcement.

Key figures: Federal funds rate: 3.50–3.75% (held since December 2025) · May headline inflation: 4.2% (3-year high) · June headline inflation: 3.5% · Core PCE (May): 3.4%, 62nd straight month above target · Rate-hike probability by September: ~73%

A dot plot that flipped the script

The Fed's quarterly Summary of Economic Projections includes a "dot plot", an anonymous chart showing where each of the 18 FOMC participants expects rates to land. As recently as March, not a single official had pencilled in a 2026 rate hike; the committee's median forecast implied one further cut by year-end. At the June meeting, nine of the 18 participants shifted to projecting at least one hike, and the median year-end rate forecast moved up from 3.4 per cent to 3.8 per cent.1

The committee's statement reinforced the shift by dropping language referencing "additional rate adjustments" in favour of a purely data-dependent stance, and its accompanying language warned that inflation "remains elevated relative to the Committee's 2 percent goal, in part reflecting supply shocks."

We've missed for five years, and we're going to fix that.

Kevin Warsh, Federal Reserve chair, on the central bank's inflation record.2

Why inflation won't cooperate

The backdrop to Warsh's pivot is an inflation picture that has whipsawed over the past several months. Headline inflation ran at a modest 2.4 per cent in February, tracking toward the Fed's 2 per cent target. That changed in late May and early June, when US military strikes on Iran triggered a near-total closure of the Strait of Hormuz, sending gas prices to their fastest weekly rise since March 2022 and pushing trailing twelve-month inflation to a three-year high of 4.2 per cent.

June brought a measure of relief: as peace talks between the US and Iran progressed, crude prices fell sharply, pulling headline inflation back down to 3.5 per cent, with forecasting tools pointing to a further easing toward roughly 3.3 per cent by year-end. But the more encouraging headline number obscures a stickier problem underneath. Core PCE inflation, the measure the Fed itself weights most heavily, since it strips out volatile food and energy prices, registered 3.4 per cent in May, its 62nd consecutive month above the Fed's 2 per cent target, and is expected to barely budge through the summer.

Headline vs. core inflation: Headline inflation includes food and energy prices, which can swing sharply due to short-term shocks like an oil supply disruption. Core inflation strips those out, offering a clearer read on underlying price pressure, which is why the Fed weighs it more heavily in setting policy, even when headline numbers look better.

That divergence is the crux of the Fed's dilemma. If the June and July improvements in headline inflation are read as durable, officials might have room to hold rates or even cut. But a core measure still stuck near 3.4 per cent, more than five years after first breaching target, suggests price pressures have broadened well beyond the energy shock that started them, precisely the scenario in which a central bank has historically felt compelled to raise rates rather than wait it out.

How markets are pricing the risk

Futures markets have moved quickly to reflect the more hawkish tone. As of early July, before the cooler-than-expected June CPI print released on July 15, CME FedWatch data implied roughly a 73 per cent probability of a rate increase by the September meeting, rising to around 81 per cent by October and nearly 88 per cent by December. Those odds have since drifted lower.

FOMC MeetingImplied Probability of a Hike
September 2026~73%
October 2026~81%
December 2026~88%

Economists have offered mixed explanations for how firmly the committee intends to follow through. One reading is that Warsh, still new to the role, leaned deliberately hawkish in his opening weeks to establish credibility on inflation before any pivot toward easier policy, a strategic signal rather than a settled forecast. In the days that followed, market analysts offered a starker read: the risk of the Fed needing to raise rates had clearly increased, given the fresh economic data on the table.3 Not every analyst agrees the hawkish pricing will hold: some research desks argue markets have overcorrected, framing a possible September move less as a return to 2022-style emergency tightening and more as an unwinding of "insurance" cuts made against what remains a fundamentally resilient economy.4

Warsh doubles down

Any hope that the June signal was tactical dissipated three days before this article was written. In his first semiannual testimony to Congress on July 14th, Warsh called for a "regime change" in the Fed's approach to policy, described inflation as "a tax on the American people," and told lawmakers the central bank had "no tolerance for persistently elevated inflation." He specifically criticised the Fed's 2020 flexible average inflation targeting framework, which allowed above-target inflation after periods of lower prices, calling it "a mistake." The cooler June CPI reading published the same morning did not soften the message: Warsh cautioned lawmakers against reading too much into a single data point.5

The stakes for an AI-driven market

The timing matters well beyond the bond market. US equities have spent much of 2026 setting record highs on enthusiasm for artificial intelligence investment, with a substantial share of the data-centre and infrastructure build-out financed through debt. A genuine shift toward higher rates would raise the cost of that financing directly, testing whether current valuations can hold up once borrowing gets more expensive.

The labour market complicates the picture. Payroll growth had appeared solid through the spring, but the June 2 BLS report revised April and May's combined figures down by roughly 74,000 jobs and showed the economy adding just 57,000 payrolls in June, with the biggest losses concentrated in leisure and hospitality. That softer read introduces at least some caution into the case for tightening, a central bank hikes more comfortably against a labour market that is unambiguously strong.

What comes next

The FOMC's next scheduled decision falls on July 28th and 29th, which will not include an updated Summary of Economic Projections, meaning markets will be parsing the statement language and Warsh's press conference remarks even more closely than usual for signs of the committee's next move. Whether the Fed ultimately hikes in September, waits until later in the year, or holds off altogether will likely hinge on how the coming months of inflation data, particularly Core PCE, resolve the tension between an improving headline number and a core reading that has refused to come down for half a decade.

Footnotes

  1. Yahoo Finance, Warsh Hawkish Shock: 9 Fed Officials Signal 2026 Rate Hike (opens in a new tab), June 17, 2026. ↩

  2. Federal Reserve, Transcript of Chair Warsh's Press Conference (opens in a new tab), June 17, 2026. ↩

  3. PBS News, New Fed Chair Kevin Warsh Holds First News Conference After Leaving Interest Rate Unchanged (opens in a new tab), June 17, 2026. ↩

  4. TradingKey, Fed May Resume Rate Hikes in September: Full Analysis of Warsh’s Hawkish Debut, Are US Stocks a Risk or Opportunity in the Second Half (opens in a new tab), June 25, 2026. ↩

  5. CNBC, Warsh Pledges Fed Policy "Regime Change" to Rid Inflation "Tax" on American People (opens in a new tab), July 14, 2026CBS News, Warsh vows to tackle inflation in first congressional testimony as Fed chairman (opens in a new tab), July 15, 2026. ↩