As we move into the second half of the year, no question carries more weight for global risk markets than the direction of U.S. monetary policy under new U.S. Federal Reserve chairman Kevin Warsh.
His first Federal Open Markets Committee meeting as chair last month offered a window into how he and the committee are approaching that question, but the signals he sent, and the structural changes he has set in motion, have pulled market expectations in sharply opposing directions.
A Hawkish Opening Move
Warsh's debut as chair left little ambiguity about his priorities. He reaffirmed the inflation mandate with notable force, made firm public commitments to meet it, and announced five internal task forces to examine the Fed’s balance sheet and data frameworks. Markets took notice immediately: by the end of the week of the Fed meeting, traders had repriced to two hikes, and the probability of a July move—in either direction—had risen sharply.
Yet beneath that initial hawkish jolt lies a more complex picture. Whether the task forces represent a deliberate mechanism to delay near-term policy decisions, or simply reflect a broader institutional reset, remains genuinely unclear. What is beyond doubt, in our view, is the deeper structural shift Warsh appears to be engineering: a move away from the forward guidance model that defined Fed communication for much of the past 15 years.
The upshot is that with less transparency on the policy path, markets will increasingly anchor on real yields and incoming data rather than Fed signals. In that sense, the split in expectations is not a temporary confusion, it is the new operating environment.
A Disinflation Story
If Warsh's tone pointed one way, the data since that meeting has pointed another. Rates have rallied. Across the curve, yields have fallen 15–20 basis points from their recent peaks—a global move, led by the U.S. but echoed in German bunds, French OATs, Italian BTPs and U.K. gilts.
The primary catalyst is energy. The market’s expectation for a resolution of the Iran conflict has driven crude prices sharply lower, with front-end contracts retracing to below pre-conflict levels and deferred prices following. That reversal has fed directly into inflation breakevens, which have fallen roughly 30 basis points from 2.50% to 2.20%—their lowest levels in 12 months.
The broader inflation picture reinforces this signal. Core PCE has printed in line. Tariff pass-through on core goods is, in our assessment, largely complete, with core goods inflation now at zero. Shelter disinflation is running at levels not seen since the depths of the Covid pandemic.
The first half of 2026 was always going to look hot; the second half is shaping up to look very different. That tale of two halves will be obscured by annual figures, but it should not be lost on the Fed, or on investors.
Our Base Case: An Elongated Hold
That disinflationary backdrop is central to how we resolve the hike-hold-cut debate—and why our answer differs from much of the street. The divide among the sell-side is unusually wide: some investment banks are calling for 75 basis points of hikes before year-end; others believe the next move is a cut, albeit delayed. We sit in neither camp. Our base case is an extended hold—no cuts in 2026 or 2027—to which we assign 40% probability. We acknowledge the right tail: the probability of hikes has risen from 5% at the start of the year to 25%, reflecting the energy shock, a stronger-than-expected labor market, and Warsh's hawkish opening. But we do not expect hikes to materialize.
The labor market, while resilient, is stabilizing rather than reheating. Payroll growth in the 50–100K range is our central expectation and last week’s nonfarm payroll numbers—a rise of 57K—broadly align with that. The Fed's task forces, whatever their ultimate purpose, offer a plausible mechanism for buying time. And a Fed watching a decelerating inflation picture while rebuilding its institutional credibility has every incentive to hold its hand. The simplest path for Warsh is to watch, wait, and let the data do the work.
Positioned for the Opportunity
That base case has direct implications for how we are managing portfolios—and the opportunity it creates is, in our view, hard to ignore. With approximately 1.5 hikes still priced into the front end of the curve, the asymmetry strongly favors duration, particularly in the two-to-five-year segment.
Even in an extreme scenario where markets fully price the 75 basis points of hikes that the most hawkish dealers are calling for, total return analysis suggests capital losses remain modest. If labor data softens—or the disinflationary second half materializes as we expect—the upside is meaningful. We have been adding duration across U.S. portfolios in the two-to-five-year range, and have selectively added TIPS on an attractive real yield basis as a tactical hedge against residual inflation uncertainty.
European portfolios have also added duration modestly, with gilts and bunds offering valuable diversification against U.S. rate risk.
The first genuine signs of two-way price action are appearing in the rates market. The hike-hold-cut debate may be unresolved, but for portfolios positioned with conviction, that uncertainty is not the risk. It is the opportunity.
What to Watch For
Monday 07/06:
- U.S. Services Purchasing Managers’ Index
- U.S. ISM Non-Manufacturing Purchasing Managers’ Index
- U.S. ISM Non-Manufacturing Prices
Wednesday 07/08:
- U.S. 10-Year Note Auction
- U.S. Federal Open Market Committee Meeting Minutes
- China Consumer Price Index
- China Producer Price Index
Thursday 07/09:
- U.S. Initial Jobless Claims
- U.S. Existing Home Sales
Friday 07/10:
- German Consumer Price Index