"Buy 2-year, sell 10-year U.S. Treasuries"! This is Wall Street's recommended "hedge Powell trade."

As Trump threatens to fire Powell, Wall Street seeks a "perfect hedge" strategy.

Trump's frequent attacks on Federal Reserve Chairman Powell are impacting the financial markets, prompting Wall Street to actively search for tools to "hedge Powell risk." James van Geelen of Citrini Research has issued trading recommendations to 50,000 clients: buy 2-year U.S. Treasuries and sell 10-year U.S. Treasuries.

According to Bloomberg, predictive market Polymarket's data shows that the probability of Powell leaving office in 2025 has risen from 18% to 22%. Mark Dowding of RBC Global Asset Management stated:

"We originally thought firing the Fed chairman was baseless and that the Fed was not subject to political interference. But the situation is clearly changing."

Last Wednesday, there was significant volatility due to news that Trump might fire Powell, with investors concerned that a loss of Fed independence could trigger inflation worries, pushing up long-term bond yields.

The yield on 30-year U.S. Treasuries jumped 11 basis points in less than an hour, and the dollar fell more than 1% against the euro. The 10-year breakeven inflation rate rose 3 basis points last week to 2.42%, close to its highest level since February.

Steepening curve trades become mainstream "hedge Powell trades" tools

The core of the "hedge Powell trade" lies in the potential shift in Fed policy.

Investors believe that if Trump successfully replaces the chairman, the new appointee may be more inclined to cut rates to appease White House pressure, thereby lowering yields on short-term U.S. Treasuries like the 2-year. At the same time, a weakening of Fed independence could trigger inflation concerns, pushing up yields on long-term U.S. Treasuries like the 10-year, resulting in a steepening yield curve.

Investors from institutions like Allspring Global Investments and Invesco stated that these positions align with their existing holdings based on economic and fiscal considerations, including bearish views on the dollar and expectations of a slowdown in U.S. growth.

Van Geelen anticipated this possibility as early as March 2024, when he advised clients to establish steepening curve trade positions, expecting that Trump would fire Powell after winning the election and appoint a new chairman more inclined to cut rates. He stated in his report at the time:

"It sounds absurd, but it could very well happen."

Inflation expectations become a "purer" hedge choice

Meghan Swiber, a U.S. Treasury strategist at Bank of America, believes that breakeven inflation rates are a more effective hedging tool.

She pointed out that the Treasury might control long-term yields by limiting long-term bond issuance, which would reduce the effectiveness of steepening curve trades.

"We see the inflation market pricing in the risks to Fed independence," Swiber stated, noting that in an environment with low unemployment and inflation still well above the Fed's target, pressure on the Fed will ultimately lead the market to perceive that inflation faces more persistent upward risks Columbia Threadneedle's global interest rate strategist Ed Al-Hussainy warned:

"The nightmare scenario is that the Federal Reserve loses its independence, tariffs push up inflation, and fiscal policy becomes more stimulative ahead of the midterm elections, all happening simultaneously."

He is betting on interest rate volatility rising from near three-year lows through options.

Increasing Discrepancies within the Federal Reserve Heighten Uncertainty

In the latest Markets Pulse survey, one-third of respondents believe that Federal Reserve Governor Waller is the preferred choice to replace Powell, followed closely by Treasury Secretary Yellen.

Although most Wall Street professionals think it would be difficult for Trump to "legitimately" fire Powell without legal challenges, investors are still preparing for this possibility.

As a potential successor to Powell, Waller hinted last Friday that he would vote against keeping interest rates unchanged if FOMC members vote to do so at the policy meeting at the end of July.

Bloomberg macro strategist Edward Harrison pointed out that if the Federal Reserve indeed follows Waller's suggestion to cut rates, long-term yields are more likely to rise against the backdrop of rising inflation expectations; even if the Federal Reserve maintains rates, dissent and uncertainty could increase term premiums, pushing long-term rates higher, or further intensifying Trump's pressure for rate cuts.

Looking ahead, the Treasury's quarterly refinancing announcement on July 30 will be a major focus, as investors will pay attention to the Treasury's decisions on long-term bond issuance, which could affect the effectiveness of steepening strategies