Market Brief: "Shadow Fed Chair" Fears Drive Dollar Lower

The dollar is trading near a three-year low and Treasury yields are down across the curve after a report suggested that Donald Trump could appoint the next Federal Reserve chair early in an attempt to push interest rates in a more favourable direction. According to the Wall Street Journal, frustration with the central bank’s easing trajectory has led the president to consider naming a successor to Jerome Powell in the coming months, with Kevin Warsh, Christopher Waller, Kevin Hassett, Scott Bessent, and David Malpass all emerging as potential contenders for a role that would be expected to steer the central bank's decision process in a more dovish direction. Markets now have 63 basis points in easing priced in by year end, up from 55 on Monday.

We’re not convinced that a Trump-aligned “shadow chair” would succeed in driving policy rates lower. The Fed is structured to avoid political interference: rates are set by twelve members who are appointed for terms that span presidential administrations, and there are no structural imperatives that demand policymakers fall behind the chair’s opinion when decisions are made. Meeting transcripts over recent decades have been overwhelmingly consistent with a consensus-driven—not top-down—process.

For now, the Fed is firmly on the sidelines. In his semi-annual Congressional testimony over the last two days, Powell said, “Increases in tariffs this year are likely to push up prices and weigh on economic activity … The effects on inflation could be short-lived, reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent”. When asked if a rate cut could come as soon as next month, Powell responded, “I think many paths are possible here … We could see inflation come in not as strong as we expect. If that were the case, that would tend to suggest cutting sooner. We could see the labour market weaken and that would also suggest cutting sooner. On the other hand, if we see inflation coming in higher or if the labour market were to remain strong, then we would probably be moving later”. “For the time being, we are well positioned to wait to learn more about the likely course of the economy before considering any adjustments to our policy rate”.

But strains are appearing in labour markets. According to data released by the Conference Board on Tuesday, the share of consumers who think jobs are “hard to get” versus the share who think they are “plentiful” dropped further to 11.1 percent from 12.7 percent in May. Although false negatives have occurred—most recently last year—drops in this so-called “labour market differential” have historically foreshadowed jumps in the US unemployment rate. An update published this morning showed the number of Americans filing continuing claims for unemployment benefits climbed again in the week ended June 13.

Incoming data could tilt the balance of opinion on the Federal Open Market Committee. Tomorrow’s personal consumption expenditures release is unlikely to change minds, but if the June payrolls number on July 3 and the consumer price print on July 15 both come in on the extremely soft end of the spectrum, market expectations for a July rate cut could jump, putting renewed pressure on the dollar.

Across the pond, the euro appears to be gathering steam for a push through the 1.20 threshold against the dollar, but there are major hurdles ahead that could cap its advance. On a trade-weighted basis, the common currency is trading near its highest levels in five years this morning, with its year-to-date gains mostly concentrated against the greenback—and the dollar-driven Chinese renminbi—as the “risk premium” embedded in US assets increases, and more dovish views on the Fed’s likely policy trajectory tighten short-term swap rate differentials in its favour. Although dollar weakness could intensify in the coming weeks if the Trump administration doubles down on its tariff increases, puts more sustained pressure on the Fed, or passes a funding bill that widens expected deficits further, none of those outcomes seems sufficient to drive another significant leg down, and it is difficult to see the domestic European trigger that could push the euro higher. The European Central Bank is unlikely to make a hawkish turn, and improved sentiment levels will take time to show up in economic data releases—if they ever do. Momentum could clearly carry the currency further, but we think the move is getting stretched, and see potential for a reset lower if the dollar finds its footing.

We don’t expect increased military spending to deliver immediate and material benefits to the European economy beyond the psychological effects, given the long time lags that typically accompany defence-related investment initiatives. Yesterday’s agreement among NATO allies requires countries to increase military spending to 5 percent of gross domestic product—3.5 percent on core defence and 1.5 percent on related infrastructure—could tilt the global balance of power more firmly toward the West, but doesn’t become binding until 2035, and isn’t set to be reviewed until 2029 (perhaps not uncoincidentally the same year in which President Trump’s second term expires). It just isn’t realistic to expect that nations already suffering from severe fiscal constraints will succeed in launching and implementing defence spending initiatives in the coming months on an economy-altering scale.

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