By Douglas Porter

June 19, 2026

Financial markets grappled with two nearly equal and offsetting forces this week: the U.S. and Iran signed a Memorandum of Understanding to halt the conflict, and Kevin Warsh chaired the FOMC for the first time. The latter was widely perceived as more hawkish than expected, with Mr. Warsh seemingly going out of his way to quash notions that he would risk inflation by unduly aiming for lower rates.

The market reaction to the FOMC countered the relief from the latest dive in oil prices, as WTI dropped nearly 10% on the week to around $77, its lowest level since early March. While still well up from the pre-war levels (low $60s), that leaves crude roughly in line with its long-run norms (in real terms).

On its own, the steep pullback in oil prices would normally have carved deeply into rate hike expectations. After all, the primary reason why we are all even talking about the possibility of hikes by some central banks—and the reality of hikes by others, such as the ECB and RBA—is that headline inflation has bounced on the oil price spike, with some threat of a spillover to core.

But if oil is now in full-scale retreat and close to long-run norms, the casus belli for hikes disintegrates. Suffice to say that markets don’t quite see it that way in the wake of Warsh’s tough talk. Instead, two-year Treasury yields rose further this week to nearly 4.2%, up 20 bps in the past three weeks and a whopping 80 bps since the conflict began. Put another way, the market is back to pricing in nearly two quarter-point Fed rate hikes by next spring.

The shifting perception on the Fed revived the U.S. dollar, which rose almost 1% in trade-weighted terms this week and is again flirting with its highest level of the past year. It was especially strong against currencies whose central banks are on hold, such as the Bank of Canada and the Bank of England, but it still rose nearly 1% against the euro even after last week’s ECB rate hike.

Of course, it doesn’t hurt the greenback’s cause that the AI/tech boom rolls on, seemingly unabated. To wit, the Nasdaq rebounded 2½% in this holiday-shortened week, largely reversing the mini-correction at the start of the month. But even the Dow hit a record high, while the S&P 500 climbed about 1% and is now up nearly 10% on the year.

We dig much deeper into the finer points of the FOMC in Focus, but it is fair to ask: What exactly did Warsh signal that made such a profound shift in views on the Fed outlook? Arguably, very little. He simply reaffirmed, in an incredibly terse statement, that the Fed was on hold and committed to controlling inflation, and that the vote was unanimous.

But perhaps more importantly it was what he didn’t say—there simply was no suggestion that he was looking to lower rates, and no defence of such. And then there were the economic forecasts (replete with higher core inflation) and the dots.

To be clear, we are very much in the skeptical camp when it comes to the dot plot, as is Warsh, given that he chose not to contribute to the exercise. But markets clearly seized on the fact that fully 9 of the 18 dots looked for rate hikes in the second half of this year. Even by the end of 2027, there are as many Fed officials seeing rates ‘higher’ as those who see them ‘lower’, from current levels—quite a change from just three months ago.

However, before reading too much into these quasi projections, we would make three points: 1) The most important dot, Warsh, was not there to be counted, while the uber-dove Miran was removed. And while no one can say for certain that he would be on the dovish side of the scale, his earlier comments to the Senate suggested so. 2) It’s always crucial to note that all 12 regional presidents can contribute dots and forecasts, but only 5 have a vote. And, traditionally, the presidents lean hawkish, which very much seems to be the case now.

So, while one can’t just automatically eliminate 7 of the most hawkish dots to arrive at what the voters would say, it may not be entirely wrong. 3) As always, the dots and forecasts are not set in stone… more like porridge. As Warsh noted, they are done in pencils with large erasers. And these calls may have been made $15 ago on oil prices.

Even with that myriad of caveats, we would readily allow that there is next to no appetite among Fed officials for rate cuts in the foreseeable future. Thus, even as we have shaved our oil price assumption based on the details of the MOU—to an average WTI of $80 this year and $75 next (from $85 and $77.5)—we have also further pushed back our call on Fed rate cuts. (Yes, cuts, not hikes.) We now see the Fed waiting until the latter stages of 2027 before resuming trims.

To briefly recap why we still lean lower, not higher, on short-term rates: Current fed funds of 3.50%-to-3.75% are still above neutral, and we see GDP growth easing to below potential next year on a tighter turn in fiscal policy after the mid-terms, as well as some cooling in AI spending growth. And, yes, we are also assuming that headline inflation recedes notably in 2027 to closer to 2%, as the spike in oil prices fades from memory.

In contrast to the bounce in U.S. short-term rates, Canadian two-year yields barely budged on net this week (a factor in the latest sag in the Canadian dollar to 70.5 cents). Having flatly told us last week that the BoC saw no signs that the energy spike was spreading to other prices, the case for hikes has withered. That’s especially so with gasoline prices now falling fast and headed for about a 10% m/m drop in June alone.

However, we first need to deal with the May inflation report (due Monday), which will be the headline event in Canadian markets next week (aside, perhaps, from a certain match with Switzerland). Pump prices rose another 5% in that month, which is likely to drive a 0.8% m/m rise in the CPI, lifting the overall inflation rate right to the 3% mark, its first 3-handle since late 2023. However, that is less ‘bad’ than many initially feared as oil was flaring higher and is well below the 4%+ inflation readings in places like the U.S. and Australia.

Excuse us if you have heard this record before, but we would conclude by reiterating once again the many reasons we believe the market is misguided in pricing in any hikes by the BoC: Core inflation is back to target, nearly by any measure; GDP and hours worked have either contracted or barely risen in the past year; housing activity remains quiet; and, the lingering uncertainty surrounding the USMCA continues to grind down on business capital spending.

Unless and until there is greater clarity around Canada’s trade relationship with the U.S., we simply do not see the case for hikes. Full stop.

Policy Contributing Writer Douglas Porter is Chief Economist for BMO.