Global investors were shell-shocked on Tuesday after U.S. President Donald Trump struck another blow at the Federal Reserve's independence, caught between the concerns over politicisation of policy and the payoffs for markets.
Trump's announcement he was firing Fed Governor Lisa Cook surprised markets, even though he had made clear last week that Cook was a target and has for months attacked Chair Jerome Powell as part of his campaign to get the Fed to cut rates.
"It's another crack in the edifice of the United States and its investibility," said Kyle Rodda, a senior financial market analyst at Capital.com in Melbourne.
Rodda said he was concerned about the motives of the Trump administration, that the move was not to preserve Fed integrity but rather to install Trump's own people at the central bank.
"It goes back to trust in institutions," he said.
While Cook's departure is not assured and she has disputed Trump's authority to remove her, that Trump said her firing was "effective immediately" just two weeks before the Fed's policy meeting, is another matter of concern for investors.
Still, market reaction was tame. Short-term Treasury yields fell slightly, while expectations such forced easing of monetary conditions will lead to inflation pushed the yield on the 30-year bond up 3.9 bps to 4.928%.
The S&P 500 stock index (.SPX) opened a slight 0.06% lower, while the dollar's index versus a basket of currencies was 0.27% easier.
"People want to see if it happens, but at the same time, it's very difficult to sell the U.S. because of the credibility issues," said Tohru Sasaki, chief strategist at Tokyo-based Fukuoka Financial Group.
One factor investors have to consider is Trump's trade deals, which require countries across Europe and Japan and South Korea to invest hundreds of billions in the United States, Sasaki said.
"If there is a lot of investment into the United States, eventually the dollar will be supported, U.S. equities will be supported. So you may just lose money making a short position in the dollar or U.S. assets."
EXCEPTIONALISM
Trump's gradual ratcheting up of his campaign to exert more influence over the path of monetary policy has already knocked confidence in U.S. sovereign debt as a safe investment, and in the exceptional advantage the dollar enjoyed as a currency of choice.
That advantage had allowed the U.S. to fund a massive national debt that currently stands at $36 trillion, and owe international investors some $26 trillion at the end of 2024.
Foreign money has been leaving U.S. markets since Trump took over as president. Global ex-U.S. equity funds have received massive flows as investors redirected capital from the United States, LSEG Lipper data shows. Investors have sold U.S.-focused funds steadily since May.
The dollar index has lost more than 9% of its value so far this year, and while U.S. stocks have been hitting record highs this month, they have lagged the double-digit gains in many other markets riding a technology and artificial intelligence boom.
Foreign official and international accounts, such as central banks and reserve managers, have also been shedding U.S. Treasuries, Fed data shows. Their holdings have dropped this year, some $35.6 billion during the week ending August 20 alone.
"Markets have not priced in the fact that Trump could go after other Fed officials. What is priced in right now is that we have a higher chance of a rate cut in September and further cuts this year," said Shoki Omori, chief desk strategist at Mizuho Securities.
"The dollar and U.S. rates will perform (based on) how aggressively Trump speaks about the Fed going forward."
