UBS On-Air: Paul Donovan Daily Audio 'The dangers of being surprised'
The desk interprets President Trump's recent comments regarding Federal Reserve Chair Powell as a significant risk to the integrity of the U.S. Federal Reserve and, by extension, to the dollar's status as a reserve currency. Per the full note from UBS's Paul Donovan, the President's admission of being 'surprised' by Powell's appointment indicates a willingness to meddle with central bank independence, which could unsettle investor confidence. The situation is precarious, particularly with inflation remaining a key concern in the market. Importantly, a politically influenced Fed chair might lead to unexpected policy actions that further complicate the economic environment, particularly if trust in the institution erodes among market participants.
What the desk is arguing
The desk frames this situation as a critical warning about the potential politicization of monetary policy. Donovan highlights the importance of rule of law for a reserve currency; any perceived flexibility in legal definitions surrounding the Fed's governance could evoke skepticism among investors and lead to depreciation of the dollar.
Donovan's commentary also reflects on the historical context where the independence of central banking has played a pivotal role in stabilizing inflation throughout the 'Great Moderation' period. As such, any threats to that independence raise red flags for traders who rely on predictability in monetary policy.
Where it sits in our coverage
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How other firms see it
Firms focusing on the stability of the Fed, such as jpmorgan, may align with concerns about central bank politicization. In contrast, firms like bofa might propose a more optimistic stance regarding the potential for swift adjustments to and recovery of markets amid political noise. Notably, the relationship between USD and global market sentiments could be illustrated through pairs like USD/JPY and EUR/USD, which often react to Fed signals and broader geopolitical contexts.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Trump's comments on Powell raise concerns about Fed independence and investor confidence.
- 02The integrity of the Federal Reserve is critical for maintaining the dollar's status as a reserve currency.
- 03Political influence on the Fed could lead to market instability and unpredictable monetary policy.
- 04Aspects of rule of law in the U.S. may impact market reactions to future Fed actions.
Market implications
Traders should be cautious around potential volatility caused by shifts in political rhetoric regarding the Fed. Pay attention to the USD's strength against major currencies, especially if signs of stress materialize ahead of potential nomination announcements for Powell's successor.
Risks to this view
Should President Trump continue to signal intent to influence or replace Powell without legal backing, it could spark a larger crisis of confidence in the Fed. This loss of trust could lead to deleveraging and volatility in FX markets, particularly if a politically aligned chair is appointed that alters current monetary strategies.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Thursday the 17th of July. US President Trump's social media posts in recent days have shown an increasingly urgent desire to change the focus of the media and social media narrative.
That narrative did shift yesterday with an afternoon of conjecture about whether Trump intended to fire US Federal Reserve Chair Powell. That change of focus may be costly. Trump declared themselves surprised that Powell was ever appointed, having personally appointed Powell during their first term.
Of course, the media and market speculation about attempts to fire Powell raise questions beyond the issue of the President's judgment. While it may get less attention, the issue of rule of law is very important. Whether a US President can fire a Fed Chair without cause and how stretched the definition of cause might be.
Rule of law is a critical criteria for a reserve currency to be a reserve currency. And if legal definitions are seen as elastic, that changes investor confidence. The question of the politicization of the Federal Reserve also looms large.
Across the advanced economies, independent central banking policy has been the dominant reason for the decline of inflation during the Great Moderation. Challenging that independence understandably makes investors very nervous. Even if the actions of yesterday are a temporary distraction and Powell serves their full term, these actions do send a signal about the sort of person the President may choose to nominate as Powell's replacement.
A complete political stooge would not be the worst case scenario. In such a situation, the assumption is that the incoming Fed Chair would be ignored by investors and the Federal Reserve alike and just sit in the corner muttering to themselves. The worst case scenario in terms of the inflation and market outlook would be the equivalent of Fed Chair Burns, who served under US President Nixon, superficially independent, but in reality the President's spokesperson at the Fed.
Trump was also musing on taxing US buyers of foreign products 10 to 15 percent. Previously, numbers of 20 percent had been invoked. This may reflect a realization of the effect of these taxes on US inflation.
Today's US June retail sales data will possibly show some effects, but it's relatively unlikely that there will be a big shift. US consumers are starting to see their spending power challenged by the assorted trade taxes as they slowly filter into consumer prices. But the initial response to that is not likely to be an immediate slowdown in spending.
Instead, consumers are likely to resort to credit cards and savings to maintain their living standards, and with rising prices, that may mean that nominal retail sales increase. We also get the June US import and export price data. No one really cares too much about US export prices at the moment, although there may be a flicker of interest in those sectors where taxing imported components has the potential to make US companies less competitive in international markets.
The real issue, though, is import prices, which are recorded before the imposition of trade taxes. If import prices start to look weaker than previous trends, it suggests exporters to the United States are absorbing some of the cost of offsetting the tariffs. If import prices continue to follow established trends – and bear in mind that for some products the trend is price deflation – then the cost of taxes falls 100% on the US aspects of the supply chain.
Judging from exporters' data, Japanese finished cars, but interestingly not Japanese car parts, are the one area where exporters have taken on some of the cost of the tariffs, at least in the short term. And the effects should really show up in the import prices for autos today. Lower Japanese car export prices in April will take a couple of months to hit US import prices because of the sailing times between the two nations.
That's all for today. Have a good day. UBS Switzerland AG – regulated by FINMA in Switzerland – its subsidiaries, or affiliates, collectively referred to as UBS.
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