U.S. Bond Investors Brace for Trump’s Pressure on the Fed

By Davide Barbuscia

NEW YORK (Reuters) – U.S. bond investors anticipate that President Donald Trump’s efforts to control the Federal Reserve will negatively impact long-dated U.S. debt. Concerns arise that a lenient Fed may struggle with inflation.

On Monday, Trump escalated tensions with the Fed, attempting to dismiss Governor Lisa Cook over questions about her pre-Fed mortgages. Cook denied these allegations, and her lawyer plans to file a lawsuit to stop the dismissal.

This move is part of Trump’s ongoing push for lower interest rates since returning to the presidency this year. Ousting Cook could give Trump’s appointees a board majority, potentially influencing future Fed policies.

John Madziyire from Vanguard noted that if Cook is removed, it may lead to a board that favors looser monetary policies, which could lower short-term yields but raise long-term yields. Higher inflation expectations might enhance term premiums, indicating increased uncertainty for investors in long-dated securities.

The market reaction to Trump’s Cook announcement was subdued due to doubts about its success. Currently, benchmark 10-year Treasury yields are around 4.27%. According to Tim Graf from State Street, yields would be lower without concerns over tariffs and Fed independence discussions.

Yield Curve Dynamics

The yield curve steepened, with short-term Treasury yields falling due to expectations of a potential easing in monetary policy, while longer-dated yields increased due to fears that aggressive cuts could spur long-term inflation. The yield curve comparing two- and 10-year Treasury yields reached its highest point since April.

BMO Capital Markets suggested that Trump’s challenge to Fed independence could lead to increased term premiums and a steeper yield curve.

Despite inflation declining from a 40-year high in 2022, it remains above the Fed’s target, limiting aggressive rate cuts amid a weakening labor market. Mistimed cuts could damage bond market confidence in the Fed’s inflation control, warned Tim Urbanowicz from Innovator Capital Management.

The new head of the Bank for International Settlements emphasized the importance of protecting central banks’ independence and focusing on inflation.

Concerns about the Fed’s independence could grow amid rising U.S. government debt levels. Gilles Moec, AXA’s chief economist, described the risk of “fiscal dominance” where maintaining cheap government financing overshadows inflation control efforts. He cautioned that high public debt may tempt the government to influence the Fed, potentially leading to higher long-term interest rates in the future.