Good morning, and happy Federal Reserve day to all who celebrate. Markets are on tenterhooks ahead of Kevin Warsh’s first meeting as Federal Reserve chair, with Treasury yields firming, the dollar advancing, and most major currency pairs trapped in tight ranges. After a copy of the US-Iran ‘memorandum of understanding’ was released by major news outlets, both global oil benchmarks are edging below $80 a barrel as traders bet on a full resumption of energy flows through the Strait of Hormuz by the end of July, with Gulf output expected to recover to near pre-war levels by early October. The Canadian dollar is under pressure, slipping below a key psychological level in early trading as lower crude prices erode the country’s terms of trade and a weak domestic economy widens interest rate differentials with the United States.

The world’s most powerful central bank is widely expected to leave benchmark rates unchanged at the conclusion of today’s meeting, but with recent data showing strong hiring, a stable unemployment rate and inflation well above target, the easing bias embedded in the statement’s language around ‘additional adjustments’ to interest rates is likely to be removed. The ‘dot plot’, which in March showed a dozen officials projecting at least one cut this year, could shift materially, with a majority now expected to pencil in rates on hold through year-end. Traders have gone further, pricing in at least one hike by December as underlying inflation accelerates and the second-round effects of the war feed through to consumer prices. This follows rate hikes from the Bank of Japan and the European Central Bank in the past week, fitting a broader pattern of central banks turning more hawkish in response to the energy shock.

This morning’s retail sales numbers are likely to reinforce the case for staying on hold. Although wealth effects are undoubtedly playing a role and there are wide variances in spending patterns across the income distribution, there are no appreciable signs of a slowdown in aggregate household consumption in any of the higher-frequency data series we monitor. This suggests that demand-led inflation pressures could compound the exogenous energy-price shock in keeping price growth elevated for some time to come.

Market fireworks, if they come, will arrive when Warsh addresses reporters during the post-decision press conference. The newly-minted chair is likely to acknowledge that economic conditions do not justify rate cuts—the data leave little room for any other conclusion. But much will depend on how he frames the outlook. He could seize on the US-Iran deal to argue that inflation will ease in the months ahead, or repeat his pre-nomination argument that the artificial-intelligence boom will raise American productivity and relieve price pressures over time—though he may face difficult questions about where the evidence for that view appears in the data. He may also outline plans for reducing the Fed’s balance sheet, a move that would raise term premia and steepen yield curves by threatening to release additional supply into bond markets. Other missteps are possible. We suspect, however, that he will seek to avoid triggering turbulence at his first outing, with language carefully designed to demonstrate awareness of the two-sided risks facing the US economy while preserving as much optionality as possible.

The pound and euro are both trading with a softening bias after British inflation data surprised to the downside. According to an update published this morning, headline prices unexpectedly held at a 13-month low of 2.8% in May, undershooting expectations that had been set above the 3% threshold, and suggesting that a weak domestic economy is restraining corporate pricing power, limiting the risk of an inflationary overheat in the coming months. The Bank of England is expected to leave rates unchanged tomorrow, and investors are growing less confident in the likelihood of a material tightening in policy by year end, with a single move now priced into swap markets, down from two at the end of last month.

Sterling looks somewhat vulnerable heading into tomorrow’s Makerfield by-election, in which Andy Burnham is expected to win a seat in Westminster, clearing the way for a leadership challenge against Prime Minister Starmer. The political risk premium could increase if he emerges victorious. But we think tail risks have been truncated by a series of statements from the Burnham camp suggesting he intends to leave fiscal settings unchanged and avoid extensive adjustments to the government’s spending plans—a message aimed squarely at gilt-market investors. If anything, the pound may be more exposed to a Reform victory, which could see investors grappling with a number of major unknowns.