Good morning. The Federal Reserve delivered a hawkish hold yesterday, leaving rates unchanged while laying the groundwork for future hikes. The statement was broadly unchanged from June, but three officials—Beth Hammack, Lorie Logan and Neel Kashkari—dissented in favour of an immediate increase, up from two at the prior meeting and illustrative of a growing tightening bias on the committee. Markets had assigned roughly one-in-three odds to a move ahead of the decision, and small position adjustments followed in its immediate aftermath.

But a credibility shock followed. Chair Kevin Warsh opened his second press conference by declaring that “this Fed will not waver” in its commitment to lowering inflation, but then argued the central bank did not necessarily need to raise rates to bring prices down, contending that a rise in bond yields between the June and July meetings had effectively tightened monetary policy, doing the committee’s work for it*. Pressed on whether the Fed could adopt inflation measures beyond the core personal consumption expenditures index, he equivocated, raising questions about whether the goalposts were being moved. Traders responded by pushing back the likely timing of a hike to later this year, and lowering rate expectations through 2027.

Curves steepened and the dollar sold off. Even as short-end rates fell, 30-year yields—tied to long-term inflation expectations—climbed to their highest since 2007 as investors absorbed an unambiguous message: investors now believe the Fed is less willing to act than its statement implies, and are demanding a higher uncertainty premium** to compensate for the risk that it waits too long.

We expect a lurch in the opposing direction. After markets overinterpreted Warsh’s performative commitment to price stability during his first press conference, they now appear to be making the reverse assumption, overlooking the fact that the chair has limited control over the wider committee. Other officials are likely to attempt to undo the damage, delivering more hawkish messages in the weeks ahead and steering markets toward expecting rates to climb this autumn. Although we still have a downbeat view on the dollar’s longer-term prospects, the stage is set for a brief rebound.

The pound is little changed after the Bank of England held rates this morning in a widely expected decision. The Monetary Policy Committee voted 6–3 to keep the base rate at 3.75%, with Catherine Mann, Megan Greene, and chief economist Huw Pill supporting a rise while no one voted for a cut. Governor Andrew Bailey said price growth has “fallen faster than we’d expected, but the conflict in the Middle East continues to mean high and volatile energy prices. That will cause inflation to rise again later this year. However the conflict unfolds, our job is to make sure any increase in inflation is temporary and that it comes back to our 2% target”. Inflation and economic output have both surprised to the downside in recent months, but another spike in energy prices has reinforced bets on further tightening, with traders expecting at least one quarter-point move by year-end, followed by another next spring.

To wit, oil benchmarks are moving higher after the US launched strikes against dozens of targets in Iran and a drone attack damaged two gas storage tankers at an Egyptian port in the Mediterranean, threatening to widen the disruption to a third pressure point. Traders are keeping a wary eye on Donald Trump’s social media accounts for the next bout of jawboning, but Brent and West Texas Intermediate are sitting near the $90 and $84 marks respectively—up roughly 47% this year—as energy shipments out of the Middle East remain well below normal.

Foreign exchange volatility remains relatively subdued ahead of this morning’s data releases, with next week’s non-farm payrolls report looming as the next potential catalyst for significant movement. Today’s US second-quarter gross domestic product and personal income and spending figures could shed light on underlying growth and inflation dynamics, but will be superseded by fresh data before the Fed meets again in September. The euro is virtually unchanged after a slightly better-than-expected second-quarter output figure, the Canadian dollar is edging higher, and the Mexican peso continues to trade across a wide range as rate differentials shift.

The Bank of Japan is expected to leave the door open to further hikes this evening while remaining circumspect on pace and timing—a combination that risks reinvigorating currency market bears. Realised volatility remains relatively low and there is no sign of the disorderly moves that typically trigger official action, but should policymakers fail to sound sufficiently hawkish, the yen could slide further below its four-decade low against the dollar, bringing verbal warnings, rate checks, or direct intervention back into play.

*This is amazing stuff. The Fed sets short-end rates, so they move on expectations of policy changes. If those changes never materialise, short-end rates will not move.

**Some might call this a “moron risk premium“, but I could not possibly comment.