Market Brief: Fed aftershocks continue to ripple across financial markets

Good morning. Oil prices are nearing pre-war levels as supertankers begin moving through the Strait of Hormuz, and the dollar is trading near a one-year high after the Federal Reserve delivered a “hawkish hold” in Kevin Warsh's first meeting as chair.

Both of the major global crude benchmarks are trading just above levels reached in the immediate aftermath of US and Israeli strikes on Iran in early March. Brent is changing hands at $78 a barrel and West Texas Intermediate at $75 after President Donald Trump* and Iranian President Masoud Pezeshkian signed a 14-point memorandum extending April's ceasefire by another 60 days. The terms are sweeping: an immediate end to hostilities on all fronts, including Lebanon; the full resumption of traffic through the Strait of Hormuz; the lifting of blockades and US sanctions on Iran; the unfreezing of Iranian assets; and a $300bn investment fund for postwar reconstruction. Iran reiterated a pledge not to build nuclear weapons—a vow it has made for decades, and one whose durability remains an open question. At least three Saudi-flagged supertankers have transited the strait since yesterday, along with an unknown number of smaller vessels carrying crude, natural gas and other products, providing the first tangible evidence that the deal is translating into physical flows.

The Federal Reserve turned unexpectedly hawkish in yesterday’s decision. Although policymakers voted unanimously to hold the benchmark federal funds rate steady for a fourth consecutive meeting, they erased earlier projections for a rate cut this year: the updated "dot plot" showed nine of nineteen officials now expecting to raise rates at least once by year-end—up from none in March—as they contend with inflation pressures tied to the Iran war and elevated energy prices. Markets had expected a more neutral set of estimates, with the median seen pointing to a prolonged period on hold, not imminent hikes.

Changes to the central bank’s communication strategy were equally dramatic. The statement was cut to roughly a third of its former length—the shortest non-emergency version since the 1990s—and stripped of anything resembling forward guidance. During the post-decision press conference, Warsh declined to say where he thought rates might need to go, arguing instead that markets should price assets based on their own reading of the economy rather than trying to second-guess the central bank. Instead, he announced five task forces covering communications, the balance sheet, alternative data sources, productivity and artificial intelligence, and the inflation framework, signalling a desire to rethink the institution's operating architecture from first principles. When pressed on specifics and timelines, Warsh repeatedly deflected, claiming that the relevant task force would address the question—a formulation that drew laughter from reporters in the room**, while also serving a purpose: it bought time without committing to a direction.

The market reaction has been profound. Futures-implied odds on a rate hike by September have jumped to more than 90%, up from less than 30% ahead of the decision, and the policy-sensitive two-year Treasury yield is near a 16-month high. The dollar is coming off its biggest intraday gain of the year, rising almost 0.85% on a trade-weighted basis, and is nearing levels reached just after the ‘Liberation Day’ tariff announcement last year.

Every major currency is down against the greenback as traders ignore domestic developments and follow rate differentials. The pound has fallen almost 1.6% over the last two sessions despite the Bank of England voting 7-2 to leave rates unchanged this morning, while the euro is trading 1.3% lower. Losses in the yen have been more restrained, with Chief Cabinet Secretary Minoru Kihara warning that authorities stand ready to intervene in response to excessive currency moves at any time. The Canadian dollar, weighed down by falling oil prices, continued trade uncertainty, an ongoing housing downturn and widening rate differentials, is down 1% over the same period.

President Trump's reaction has—thus far***—been considerably more muted. Asked last night whether the Fed might raise rates this year, he said “It could happen. It's hard to believe. It just keeps the country down and it's so unusual. But we have a very good guy over there right now so I'm guided by what he ‌wants”.

From a broader standpoint, it is difficult to see volatility assumptions reverting to pre-Warsh levels. The outlook for monetary policy has become genuinely unclear, and markets have been left without a working model of the Fed's reaction function. It is hard to tell whether the new chair intends to guide the committee toward a pure inflation-targeting framework in which labour-market conditions play second fiddle to price stability, or whether he plans to follow through on the dovish rhetoric that preceded his appointment—and, presumably, led President Trump to nominate him.

Markets are now vulnerable, perhaps to a greater extent than at any point since the Greenspan era****, to sustained periods of serious mispricing. The academic evidence on the efficacy of forward guidance—the practice of signalling the likely path of interest rates—is unclear*****, but the Fed's retreat could strip currency markets of one of their most important anchors. Without periodic course corrections and a fundamental understanding of the central bank’s decision framework, the market's collective best guess could become noisier and more prone to herding, momentum and overshooting—conditions in which currencies could remain misaligned for months before a correction arrives. For corporates hedging cross-border exposures and investors managing global portfolios, the costs could be substantial: bigger trading frictions, more volatile interest-rate assumptions, and more violent or prolonged swings in exchange rates. By simplifying its approach to communication, the Fed may have made life far more complicated for the rest of us.

(Apologies for the late distribution this morning, experienced a hotel internet connection problem)

Also please note: with major US and Canadian stock markets closed tomorrow in observance of the Juneteenth holiday, we will give your inboxes some brief respite. Normal coverage will resume on Monday.

*Trump signed the agreement at the Palace of Versailles, the site of the signing of the eponymous treaty that ended World War One and set the stage for World War Two. **As one social media wag suggested, taking a drink on every mention of “task force” would have led to serious inebriation by the end of the presser. ***The countdown to the first social media post targeting Warsh has begun. My money is on "Too Late Powell" giving way to "Wishy Warshy." ****Greenspan famously mastered the art of “mumbling with great incoherence,” once telling a Senate committee “If I seem unduly clear to you, you must have misunderstood what I said”. *****As in many monetary policy debates, there’s a lack of counterfactuals: most central banks adopted forward guidance at nearly the same time, and major variances between interest rate regimes over recent history make it difficult to find an example in which the practice smoothed—or increased—volatility.

Market Overview

Data as of 7:15 AM EDT

Notes: DXY: Dollar index, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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