Introduction to the Situation
President Donald Trump has recently suggested that Federal Reserve Chair Jerome Powell should resign immediately if allegations about misleading Congress over renovations to the Fed’s headquarters are true. This has added to the growing criticism of Powell by Trump, who has been pushing for aggressive interest rate cuts. Despite the pressure, Powell has stated that he will not step down if asked by the president, citing the Fed’s independence.
The Potential Risks
George Saravelos, Deutsche’s global head of FX strategy, has warned that the market is underestimating the risk of Powell being removed from office. According to a betting platform, there is less than a 20% chance of this happening, but Saravelos believes that the consequences would be severe. If Trump were to force Powell out, it could lead to a significant drop in the value of the US dollar and a rise in Treasury yields.
Potential Market Reactions
In the event of Powell’s dismissal, Saravelos predicts that the trade-weighted dollar could fall by at least 3% to 4% within the first 24 hours. Additionally, there could be a 30 to 40 basis point fixed-income selloff, which would lead to a "persistent" risk premium for the dollar and bonds. Investors may also become anxious about the potential politicization of the Fed’s swap lines with other central banks.
Global Implications
The consequences of Powell’s removal would not be limited to the US. As the Fed is a pivotal part of the global dollar monetary system, the effects would be felt worldwide. Saravelos notes that investors would view such an event as a direct attack on the Fed’s independence, putting the central bank under extreme pressure.
Factors Affecting Market Reactions
The way markets react to the news would depend on several factors, including whether other Fed officials publicly support the central bank’s independence, Trump’s nomination for Powell’s successor, and the state of the economy. Saravelos also warns that the US economy’s vulnerable external funding position could lead to larger and more disruptive price moves.
Alternative Perspectives
Other strategists, such as those at ING Groep NV, believe that an early exit by Powell is unlikely but would still have significant consequences. They predict that it would lead to a steepening of the Treasury yield curve, as investors price in lower rates, faster inflation, and diminished Fed independence. This would create a "toxic mix" for the dollar, with the euro, yen, and Swiss franc likely to benefit.
Conclusion
In conclusion, the potential dismissal of Jerome Powell by President Trump is a significant risk that could have far-reaching consequences for the US dollar, Treasuries, and the global economy. While the market may be underestimating this risk, it is essential for investors to be aware of the potential implications and to monitor the situation closely. The effects of such an event would depend on various factors, including the reactions of other Fed officials, the state of the economy, and the US economy’s external funding position.
