Currency war, market instability looms if Trump moves to replace Federal Reserve chair Jerome Powell early
Investors are bracing for a renewed assault on central bank independence that could weaken the US dollar and complicate Australia’s monetary policymaking.
Business
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US President Donald Trump’s reported plan to name Federal Reserve chair Jerome Powell’s successor months ahead of schedule threatens to unleash fresh volatility across financial markets.
According to The Wall Street Journal, Mr Trump is considering naming Mr Powell’s replacement as early as September – eight months before his term expires in May 2026.
Concern about such an unprecedented move to undermine Mr Powell’s authority and pressure the Fed into deeper rate cuts saw the US dollar index fall 0.4 per cent to fresh three-year lows on Thursday.
A corresponding rise in the Australian dollar to US65.36c left the local currency near its highest point since November. US bond yields fell about 2 basis points amid speculation the Fed may restart interest rate cuts next month. US stock index futures turned up slightly.
The S&P 500 has bounced 26 per cent from its April low as concerns about US trade policy and Middle East risks receded. However, any move to undermine Fed independence could rekindle the “Sell America” theme that emerged when Mr Trump ramped up tariffs in April.
Bank of America’s fund manager survey this month showed investors were already heavily positioned against US assets. Perhaps this will mute the short-term impact of the WSJ report.
And of course, rapid-fire US interest rate cuts could provide short-term support to stock valuations. The US President has called for 2 to 3 percentage points of additional cuts.
But politically motivated interest rate cuts could undermine investors’ confidence in the Federal Reserve’s inflation-fighting credibility.
IG market analyst Tony Sycamore warns that Mr Trump’s pick will inevitably sit “at the highly dovish end of the spectrum” and support aggressive rate cuts that could fundamentally undermine Fed independence. Such an erosion of institutional credibility poses risks for the global monetary system, potentially triggering competitive devaluations as other central banks respond to US policy accommodation. For Australian markets, Mr Trump’s gambit represents a potentially destabilising force that could reshape currency dynamics, bond yields and equity valuations.
The most immediate impact will likely hit currency markets. While a stronger Australian dollar might initially benefit consumers and import-dependent businesses, the implications are complex.
A persistently weak US dollar could complicate the Reserve Bank’s policy considerations, particularly as local inflation pressures ease.
Rapid Australian dollar appreciation would effectively tighten monetary conditions through the exchange rate channel, potentially forcing the RBA to cut rates more aggressively than domestic conditions alone would warrant.
A weaker US dollar typically supports commodity prices, benefiting Australia’s resource-heavy economy. However, political uncertainty surrounding Fed policy could increase market volatility, making Australian commodity exports vulnerable to sudden shifts in global risk sentiment.
Australian government bond markets face particularly complex dynamics.
While falling US Treasury yields might initially support local bonds through global yield curve effects, an underlying erosion of central bank credibility could prove more damaging.
If markets seriously questioned the Federal Reserve’s commitment to price stability – as during the “great inflation” of the 1970s – long-term inflation expectations could become unanchored, with devastating implications for economic growth.
Bond vigilantes could demand higher risk premiums across developed markets as compensation for increased policy uncertainty.
The timing is awkward for Australian bond markets, which have rallied on expectations of domestic rate cuts following softer inflation data. CBA, Westpac, AMP, RBC, Deutsche, HSBC and Morgan Stanley economists now expect the RBA to cut again in July.
But a sudden shift in global monetary policy dynamics could leave local investors caught between improving domestic fundamentals and deteriorating global policy credibility.
Australian equity markets face similarly complex prospects.
Aggressive US rate cuts might initially support risk assets through global liquidity channels, but political interference could ultimately prove counter-productive for market confidence.
The resources sector, comprising about 20 per cent of the ASX, could benefit from both a weaker US dollar and commodity price support.
However, this support could prove fleeting if political pressure on the Fed triggers broader concerns about institutional stability.
Financial sector stocks face particular challenges, with Australian banks already confronting squeezed net interest margins from domestic rate cuts.
Further complications from US monetary policy interference could extend this weakness.
Perhaps most concerning is the broader regional context.
If Fed independence becomes compromised, it could encourage similar political interference elsewhere, potentially destabilising the entire framework of independent central banking that has underpinned global financial stability for decades.
The Bank of Japan has already begun reversing ultra-accommodative policy, and additional pressure on global monetary policy co-ordination could complicate these efforts.
For Australia, which maintains significant trade and financial linkages with both the US and Asian economies, such policy fragmentation could prove particularly disruptive.
At this stage, it’s unclear whether Mr Trump’s Fed gambit represents temporary political theatre or the beginning of a fundamental shift towards politically influenced monetary policy globally.
The full implications for Australian markets will depend on how aggressively Mr Trump pursues his plan and whether other major central banks feel compelled to respond.
Australian markets may benefit from global liquidity effects of anticipated US rate cuts.
But longer-term risks to institutional credibility could prove far more damaging, particularly if Mr Trump’s approach spreads to other jurisdictions.
At a minimum, investors should prepare for increased volatility across all asset classes as markets grapple with politically compromised monetary policy in the world’s largest economy.
Originally published as Currency war, market instability looms if Trump moves to replace Federal Reserve chair Jerome Powell early
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