Deutsche Bank: markets are underestimating the risk of Powell's departure. What could be the consequences?

Deutsche Bank named the possible resignation of US Federal Reserve Chairman Jerome Powell as one of the biggest underestimated risks in the coming months. According to the bank's analyst, if Donald Trump fires the Fed chairman before the end of his term, it could cause a collapse of the dollar and the U.S. bond market, inflation expectations will intensify and confidence in the independence of the regulator will be undermined. 

Investors are seriously underestimating the risk that Trump might fire Powell, according to Georgios Saravelos, head of currency research at Deutsche Bank, reported by Business Insider. Markets are now laying the probability of such a scenario at just 19%, according to Polymarket data. Trump and Powell have long been at odds, with the president regularly pressuring the Fed to cut rates and repeatedly publicly criticizing Powell for refusing to do so. 

Last week, the situation escalated: Trump administration spokesman Russell Voughtaccused Powell of overspending the $700 million budget for renovations to the Fed building and called for an audit of his work. And among those who rebuked the head of the regulator are those named as candidates for the position, writes Yahoo Finance. Kevin Hassett, chairman of the U.S. National Economic Council, said the Trump administration is looking into whether it has legal grounds to fire Powell, while Kevin Warsh, a former member of the Fed's Board of Governors, called the renovation project an example of what he believes is the Fed "off course."

Deutsche Bank emphasizes that such statements should not be ignored. Especially since Trump has already considered removing Powell before his term expires and appointing his own candidate, notes Seeking Alpha. 

Saravelos believes that investors will see Powell's firing as a blow to the Fed's independence, which will put pressure on the entire U.S. financial system and affect global markets. He notes that the consequences will be much more serious than in the 1970s, when former President Nixon interfered in the work of the Fed, reports Fortune. The publication reminds us that he and Fed chief Arthur Burns, who was appointed by him, were also fixated on lowering rates and thus contributed to the stagflation of that decade. Now, according to a Deutsche Bank analyst, the U.S. has larger budget and trade deficits, open markets and a free exchange rate, which means the risk of global turmoil is much higher.

The first alarming signal in case of Powell's resignation will be a sharp fall of the US dollar, the analyst warns. In the first half of the year, the U.S. currency has already weakened by almost 10% - the worst result in recent years. In the first day after the dismissal of the head of the Fed, according to Deutsche Bank, the dollar may fall by at least 3-4%, and the yields of U.S. bonds will grow by 30-40 basis points, especially on securities with long maturity;

"Borrowing costs would rise the very next day, inflation would accelerate - in the end, the exact opposite of what Trump seeks to achieve by criticizing Fed policy would happen. The evidence on the consequences of the loss of central bank independence is clear: in extreme cases, both the currency and debt markets could collapse simultaneously due to rising inflation expectations, falling real yields and rising risk premiums amid eroding institutional resilience," Saravelos said. He added that even without political risks, bond yields are already under pressure due to the growing U.S. budget deficit. Powell's dismissal against this backdrop will only increase instability and could trigger much sharper and larger movements in the markets than those seen so far.

Further market reaction will depend on whether the remaining members of the Fed will rally around the independence of the regulator and Powell's successor, said an analyst at Deutsche Bank.

At the same time, he said, even if the dismissal will not come to the dismissal, the conflict between the head of the Federal Reserve and Trump itself already creates long-term uncertainty, so that the value of the dollar and the yield of treasuries will be a constant risk premium, and their dynamics will become particularly sensitive to any economic data and decisions of the Fed in the coming months.

In June, the Fed left the rate unchanged for the fourth consecutive time but predicted two more rate cuts this year. Powell reiterated that the regulator needs to wait for fresh inflation data over the summer months to see a fuller picture of the impact of Trump's duties on the economy and then make a decision. According to CME FedWatch, a tool that monitors market expectations for the U.S. Fed Funds rate, 95% of traders believe the regulator will keep the rate at the same level again at the end of its next meeting in July.

This article was AI-translated and verified by a human editor