US Treasury Yields Spike Amid Fed Independence Concerns

US Treasury Sell-Off Sparks Concerns Over Fed Independence

On Tuesday, US Treasury bonds experienced a significant sell-off, driven by investor concerns that President Trump's attempts to dismiss a Federal Reserve governor could undermine confidence in the world's most important central bank. These concerns arrive at a sensitive time, as the market closely monitors the trajectory of US monetary policy. The sell-off pushed the gap between US long- and short-term Treasury yields to its widest level in nearly three years. This widening reflects investor expectations that increased political pressure will lead to lower interest rates in the short term, but higher rates in the future as Fed officials are forced to combat higher inflation. Earlier, Trump announced that he would dismiss Fed Governor Cook, “effective immediately,” citing allegations of mortgage fraud. Removing Cook would enable the US president to pick a replacement more open to interest rate cuts. Some view this move as an attempt to pressure the Fed to ease monetary policy ahead of the upcoming presidential election.

Impact on Dollar and Bond Yields

On Tuesday, the dollar weakened, and two-year US Treasury yields fell to 3.7%, as investors anticipated downward pressure on the Fed's policy rates. Thirty-year US Treasury yields rose 0.06 percentage points, and the gap between the two reached over 1.2 percentage points – close to its highest intraday level since market turmoil in April after Trump’s “Liberation Day” tariff announcement. Later on Tuesday, 30-year US Treasury yields retraced somewhat, to 4.91%. Marieke Blom, chief economist at ING, said, “If successful, this would be a material weakening of Fed independence, and when central bank independence is lost, people pay a high price through higher inflation and higher interest rates.”

Risks of 'Fiscal Dominance'

Goldman Sachs said Tuesday morning that “the market reaction to these headlines seems more indicative of general risk aversion to US assets rather than purely a dovish policy shock.” It added: “The challenge to Fed independence poses a clear downside risk to the dollar.” In recent months, investors have grown increasingly uneasy about Trump's criticism of Fed chair Powell, his temporary appointment of Stephen Moore, and the firing of the chief statistician. Over recent decades, central bank independence and reliable economic statistics have been a cornerstone of developed markets, and US Treasuries have provided benchmark interest rates underpinning trillions of dollars of financial assets. Elizabeth Warren, the top Democrat on the Senate banking committee, accused Trump of a “dictatorial-style power grab,” while legal scholars said the White House would have to prove cause to fire Cook in court.

Long-Term Implications

Ed Al-Hussainy, senior rates analyst at Columbia Threadneedle Investments, said, “I see the actions that the White House has taken to pressure and intimidate Powell and Cook as part of a tactic designed to weaken and ultimately eliminate the statutory independence of the Fed.” Fraser Lundie, global head of fixed income at Aviva Investors, said any government that “exhibits instability in institutional arrangements and the risk of direct political influence” will lead to a weaker currency, a steeper government bond yield curve, and the higher so-called risk premium attached to long-dated debt. On Tuesday, the dollar fell 0.3% against a basket of similar currencies, including the euro and the British pound. The dollar has fallen more than 9% this year, as Trump’s trade and broader policies have affected the US economic outlook and investor sentiment toward the US. Economists and investors say Trump's pressure on the Fed is the most prominent example of the new alleged era of “fiscal dominance,” where central bank policy is more determined by the government’s need to keep borrowing costs low to service massive debts. George Saravelos, an analyst at Deutsche Bank, said: “In our view, there is little doubt that the Fed is now facing increasing risks of fiscal dominance, but what surprises us more is how little the market is worrying about it, and investors are too complacent about this risk.” Analysts warn that fiscal dominance could lead to higher inflation and undermine investor confidence in the US economy.