Investors believe that if Trump successfully replaces the chairman, the new appointee may be more inclined to cut interest rates to satisfy pressure from the White House, thereby lowering the yields on 2-year and other short-term U.S. Treasury bonds. At the same time, the weakening of the Federal Reserve's independence could trigger inflation concerns, pushing up yields on 10-year and other long-term U.S. Treasury bonds, exacerbating the steepening of the yield curve. Some Analysts also believe that the breakeven inflation rate is a more effective hedging tool.
As Trump threatens to fire Powell, Wall Street seeks the 'perfect hedge' strategy.
Trump's frequent attacks on Federal Reserve Chairman Powell are impacting the financial markets, pushing Wall Street to actively seek tools for 'hedging Powell risk.' James van Geelen from Citrini Research has issued trading advice to 0.05 million clients: Buy 2-year U.S. Treasury Bonds, Sell 10-year U.S. Treasury Bonds.
According to Bloomberg, data from forecasting agency Polymarket shows that the probability of Powell leaving office in 2025 has risen from 18% to 22%. Mark Dowding from RBC Global Asset Management stated:
"We initially believed that firing the Federal Reserve Chairman was baseless and that the Fed is not subject to political interference. But the situation is clearly changing now."
Last Wednesday, there was significant volatility due to the news that Trump might fire Powell, with investors concerned that the Fed's independence could be compromised, potentially triggering inflation fears and pushing up long-term bond yields.
$U.S. 30-Year Treasury Bonds Yield (US30Y.BD)$ Jumped 11 basis points in less than an hour, with the dollar declining over 1% against the euro. The 10-year breakeven inflation rate rose 3 basis points last week to 2.42%, nearing the highest level since February.
Steepening Trade has become the mainstream "Hedge Powell Trade" tool.
The core of the "Hedge Powell Trade" lies in the possible shift in Federal Reserve policy.
Investors believe that if Trump successfully replaces the Chairman, the new appointee may be more inclined to cut interest rates to appease White House pressure, thereby lowering the yields on 2-year and other short-term U.S. Treasury Bonds. At the same time, the weakening of the Federal Reserve's independence may trigger inflation concerns, pushing up the yields on 10-year and other long-term U.S. Treasury Bonds, leading to a steepening of the yield curve.
Investors from Institutions such as Allspring Global Investments and Invesco stated that these positions align with their existing holdings based on economic and fiscal considerations, including Put on the dollar and expectations of a slowdown in U.S. growth.
Van Geelen envisioned this possibility back in March 2024, when he advised clients to establish steepening trade positions, anticipating that Trump may dismiss Powell and appoint a new chairman more inclined to cut interest rates after winning the election. He stated in his report at the time:
"It sounds outrageous, but it's completely possible to happen."
Inflation expectations become a "purer" hedging choice.
Meghan Swiber, a U.S. Treasury Bonds strategist at Bank of America, believes that the breakeven inflation rate is a more effective hedging tool.
She pointed out that the Treasury might control long-term yields by limiting the issuance of long-term Bonds, which would reduce the effectiveness of steepening curve Trades.
"We see the inflation market pricing in the risks to the Fed's independence," Swiber said. In an environment with low unemployment and inflation still far above the Fed's target, pressuring the Fed will ultimately lead the market to believe that inflation faces more persistent upward risks.
Columbia Threadneedle's global interest rate strategist Ed Al-Hussainy warns:
"The nightmare scenario is that the Fed loses its independence, tariffs push up inflation, and fiscal policy becomes more stimulative before the midterm elections, all happening at the same time."
He is betting on interest rate volatility rising from near three-year lows through Options.
Increased divisions within the Fed heighten uncertainty.
In the latest Markets Pulse survey, one-third of respondents believe that Fed Governor Waller is the top choice to replace Powell, closely followed by Treasury Secretary Bessent.
Although most Wall Street insiders believe Trump would find it difficult to "legitimately" fire Powell without legal challenges, investors are still preparing for that possibility.
As a potential successor to Powell, Waller hinted last Friday that he would vote against maintaining the interest rates unchanged if the FOMC members decide to do so at the policy meeting at the end of July.
Bloomberg macro strategist Edward Harrison pointed out that if the Federal Reserve follows Waller's recommendation to cut interest rates, amidst rising inflation expectations, long-term yields are more likely to rise; even if the Federal Reserve maintains interest rates, dissent and uncertainty may increase term premiums, pushing long-term rates up further, or intensifying Trump's pressure for rate cuts.
Looking ahead, the quarterly refinancing announcement from the Treasury on July 30 will be a major focus, as investors will pay attention to the Treasury's decision on the issuance of long-term Bonds, which may affect the effectiveness of the curve steepening strategy.
Editor/rice