A potential ouster of Federal Reserve chair Jerome Powell by U.S. President Donald Trump could "collapse" both the currency and bond markets and would lead to a spike in inflation expectations, Deutsche Bank said on Friday.
Earlier this week, Russell Vought, the director of the Office of Management and Budget, accused Powell of "grossly" mismanaging the Fed and said the central bank was "way over budget" on the renovation of its headquarters, with the cost of the project ballooning to roughly $2.5B.
The accusation potentially opens up an avenue for Trump to seek Powell's removal. The President has repeatedly criticized the Fed chief for not lowering interest rates and has called him a range of names. He has reportedly considered dismissing Powell and naming his successor much ahead of the end of his term.
Deutsche Bank's head of FX research, George Saravelos, noted that the market was currently pricing in a very low probability of a Powell ouster. According to prediction platform Polymarket, the odds of such an event currently stand at 15%.
But Saravelos offered a few thoughts on the possible implications.
"The empirical and academic evidence on the impact of a loss of central bank independence is fairly clear: in extreme cases, both the currency and the bond market can collapse as inflation expectations move higher, real yields drop and broader risk premia increase on the back of institutional erosion. Interestingly, the impact on equities has been far more ambivalent given they are ultimately a claim on real assets," he said.
"It is hard to quantify the impact on FX and rates, but on the first 24 hours of an announcement of a Powell removal we would expect a drop in the trade-weighted dollar of at least 3%-4% accompanied by a 30-40bps sell-off in U.S. fixed income led by the back-end," Saravelos said.
As per the analyst, the market's reaction beyond the initial news would depend on if the remaining Fed policymakers "coalesce" around the central bank's independence, Powell's successor pick, and the broader macroeconomic context.
"In sum, we consider the removal of Chair Powell as one of the largest underpriced event risks over the coming months," he added.
For Wall Street this week, trade developments grabbed the headlines, overshadowing monetary policy and the Fed. Here are some exchange-traded funds that track the benchmark S&P 500 index (SP500): (NYSEARCA:SPY), (NYSEARCA:VOO), (NYSEARCA:IVV), (NYSEARCA:RSP), (NYSEARCA:SSO), (NYSEARCA:UPRO), (NYSEARCA:SH), (NYSEARCA:SDS), and (NYSEARCA:SPXU).
To track currency, here is the U.S. dollar index (DXY) and some related ETFs: (NYSEARCA:UUP), (NYSEARCA:USDU), and (NYSEARCA:UDN).
And here are some fixed-income linked funds: (NASDAQ:TLT), (NYSEARCA:TLH), (NASDAQ:IEF), (NASDAQ:IEI), (NASDAQ:SHY), (NYSEARCA:SGOV), (NYSEARCA:SCHO), (NYSEARCA:BIL), (NYSEARCA:AGG), (NASDAQ:BND), (NASDAQ:VCIT), (NYSEARCA:MUB), (NASDAQ:MBB), (NYSEARCA:JNK), (NYSEARCA:LQD), (NYSEARCA:HYG), and (NYSEARCA:TIP).
