The yield on the 10-year U.S. Treasury bond soared 2 basis points to 4.18% Monday in response to news that Justice Department is conducting a criminal investigation into Fed chair Jerome Powell over his Congressional testimony on the Fed’s building project.
Yep, this major escalation of the Trump Administration’s campaign to force the Fed to cut interest rates more deeply and at a faster pace produced almost no reaction in the bond market.
Powell’s term as Fed chair is up in May. President Donald Trump is expected to send a nomination to an open Fed seat up to the Senate for confirmation by the end of January. And the betting is that this nominee, if confirmed, will be picked by President Trump as Federal Reserve chair in May.
I think the market’s complacency is easy to understand–the consensus seems to be that the new Fed chair won’t be completely terrible and won’t totally cave in to the President. After all, no one who cared about the Fed as an institution would just do the president’s bidding. And the Trump Administration has got to recognize the likelihood that an administration flunky as head of the Fed would push up interest rates as the financial markets began to seriously worry about the possibility that the Fed would give up on fighting inflation.
And besides, the market seems to feel, this won’t happen until May.
I think the market is dead wrong in its complacency. All the evidence is that Trump will nominate someone who will give him exactly the lower rates that he wants on the schedule he wants.
The financial markets aren’t good at pricing in uncertain future events. But it will eventually begin to price in the disastrous consequences of the Fed’s capitulation to the White House. I think it’s likely that this “pricing in” will be led by international bond buyers demanding a higher yield to compensate for a higher risk of higher inflation. Which is good for a continued rally for gold. Overseas central banks already see gold as an asset that is a reliable source of steady value.
Besides the skepticism that the next Fed chief will face from the financial markets over whether monetary policy will be set based on hard economic reality versus presidential whims, the new Fed chair is likely to find building consensus inside the Fed extremely challenging. It will be tough for the next chair to convince his colleagues that his arguments for lower interest rates are based on sound monetary economics rather than simply an echo of White House demands.
I don’t think you need to run for the hills immediately, butt I certainly would be reducing my portfolio exposure to Treasuries and taking seriously the prospect that the markets will decide to drive interest rates higher–no matter what Fed policy is on the short-term rates it controls.
