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While emerging details of the US-Iran peace deal sent oil prices to their lowest level since early March, investor sentiment remains fragile ahead of the US open on Wednesday as markets await the conclusion of the first Federal Open Market Committee meeting chaired by Kevin Warsh. The S&P 500 fell 0.6% on Tuesday, and the 10-year US Treasury yield held around 4.43%.

The US central bank is widely expected to keep the federal funds rate unchanged at 3.50-3.75% for a fourth consecutive meeting, against the backdrop of rising inflation and a stable unemployment rate. But given how market expectations on the Fed’s policy outlook have shifted since the last FOMC meeting, investors will be looking for clues from Warsh’s press briefing and the Fed’s economic projections about the policy trajectory.

Warsh will likely walk a tightrope between different measures of inflation. At his confirmation hearing in April, Warsh emphasized the need for a “regime change” in monetary policy that would alter how inflation is measured and interpreted. He noted that policymakers should place greater weight on median and trend-based inflation measures rather than relying primarily on core PCE. Given his previously more dovish stance, markets will be assessing how Warsh bridges the ongoing divergence across underlying inflation indicators. How he forecasts inflation will progress and how he communicates with markets as Fed chair are also key to watch. Overall, we expect a more hawkish tone to the Fed meeting, with the easing bias likely removed from the post-meeting statement.

The dot plot for 2026 is likely to indicate no change in the policy rate. Another hawkish element of the meeting will likely come from the “dot plot”—the chart that records each Fed official’s projection for the central bank’s policy rate. Relative to March, we expect the dot plot this month to shift toward a no-cut median projection for 2026, with multiple participants revising their rate forecasts higher. Still, we expect the policy rate to ultimately move toward a 3-3.25% range, as softer growth conditions in the second half of this year and moderating price pressures should allow the US central bank to make its policy rates less restrictive.

The Fed’s bond holdings may also come into the spotlight. Warsh has flagged his belief that the Fed’s bond holdings should be reduced, arguing that policy rate adjustments are more effective at influencing the broader economy, while balance sheet policy primarily affects financial asset prices. While he may reiterate his preference for a reduced role for the Fed’s balance sheet, guidance on the optimal size of the balance sheet and the timing of future changes remain to be seen. However, such policy moves are unlikely without changes to banking regulations, which is a key factor limiting a reduction and rarely a fast-moving process.

Overall, while the Fed meeting may lean on the hawkish side, we maintain the view that the hurdle for rate hikes is high. We believe favorable base effects should lead to a marked improvement in headline inflation in early 2027, and the potential risk of labor market displacement by AI could shift the Fed’s focus back toward downside risks to labor and growth. With markets continuing to overestimate the extent of Fed tightening, we see an attractive risk-return profile for short- to medium-maturity quality bonds.