The market has begun trading "Loss of Federal Reserve Independence": U.S. stocks, bonds, and gold are the most significant

Market concerns about the independence of the Federal Reserve are manifesting in the trading of multiple asset classes.

According to reports from the Chase trading desk, JP Morgan analyst Nikolaos Panigirtzoglou and his team recently released a report stating that concerns about potential damage to the independence of the Federal Reserve are quietly becoming a trading theme in the market, particularly evident in the U.S. stock market, bond market, and gold market.

Over the past month, the political pressure exerted by the Trump administration on the Federal Reserve has escalated, raising widespread concerns among economists and analysts about the central bank's independence. Since August 7, when Trump announced the nomination of Miran to fill the vacancy on the Federal Reserve Board, and the threat to fire board member Cook on August 22, market worries about the Federal Reserve's independence have continued to intensify.

Following these events, value stocks, commodities, and gold prices, which typically benefit from inflation concerns, have risen, while the 5-year/30-year U.S. Treasury yield curve has steepened, and the dollar's response has been relatively muted.

The report notes that this "Federal Reserve independence trade" has shown limited performance in the foreign exchange market, with the overall net position of the dollar remaining stable since Miran's nomination. Meanwhile, the risk appetite indicator based on the relative positions of risk currencies and safe-haven currencies continues to signal bullishness for risk assets such as stocks and credit.

Value Stocks and Gold Rise, Dollar Response Muted

The market's reaction to concerns about the Federal Reserve's independence shares similarities with, yet also differs from, the so-called "inflation trade." Since the news of personnel changes in early August, the price trends of various assets have diverged significantly.

According to data compiled by JP Morgan, from August 6 to September 3, the Dow Jones Market Neutral Value Index rose by 6.5%, gold prices increased by 4.9%, while the S&P 500 Index only rose by 1.1% during the same period. In the commodities sector, the Bloomberg Commodity Index (BCOM) rose by 3.5%.

The report indicates that these assets typically perform well when inflation expectations rise, suggesting that the market believes a less independent Federal Reserve may tolerate higher inflation to stimulate an "overheated" economy.

In the bond market, the yield curve between 5-year and 30-year U.S. Treasury bonds steepened by 19.5 basis points. In contrast, the response of the broad dollar index and the 5-year/5-year forward inflation swap (a measure of long-term inflation expectations) has been relatively muted.

The report states that the dollar even rebounded during the stock and bond market sell-off on September 2, indicating that the trading logic of the foreign exchange market regarding this theme is not as clear as for other assets.

Bond Market Bets on Steepening Curve

Concerns about the Federal Reserve's independence are particularly prominent in the pricing of the bond market, mainly reflected in bets on the shape of the yield curve. A Federal Reserve with compromised independence may implement more dovish policies, lowering front-end rates, which could lead to a steepening of the yield curve. JP Morgan discovered through tracking the short positions of major bond ETFs that since early August, especially after August 21, the short positions of the IEI ETF, which tracks 3-7 year U.S. Treasury bonds, have decreased relative to the TLT ETF, which tracks bonds with maturities of 20 years or more. The report suggests that this indicates an increase in steepening bets consistent with the "Federal Reserve independence trade."

Additionally, the short positions of the TIP ETF, which tracks Treasury Inflation-Protected Securities (TIPS), have decreased since August 19, while the short positions of the TLT ETF have been increasing. This change may coincide with preliminary media reports urging an investigation into Director Cook, reflecting market concerns about long-term inflation, known as the "breakeven inflation rate widening."

Value Stock Rotation Becomes Main Performance in Stock Market, Gold Directly Benefits

In the stock and commodity markets, investor positions also confirm this trading theme.

In the stock market, the rotation of value stocks has become the core performance of the "Federal Reserve independence trade."

The report's analysis shows that the interest rate gap for shorting a "short value" stock basket relative to shorting a "long value" stock basket exhibited a "rather sharp discontinuous widening" after the announcement of Miran's nomination on August 7, consistent with the trend of investors shifting towards value stocks.

In the commodity sector, gold is seen as a more direct manifestation of the "Federal Reserve independence trade." Futures position data indicates that following the news of Cook potentially being dismissed, the long positions in gold futures "sharply increased," while the increase in oil futures positions was more moderate.

The report believes that while the motivation for calling for a Fed rate cut is partly to support growth, which generally benefits commodity prices, gold, as a safe-haven and anti-inflation asset, is more sensitive to changes in central bank credibility.

Dollar Positioning Shows Cautious Trading

Unlike other assets, the forex market's response to the "Federal Reserve independence trade" is the most ambiguous.

The report analyzes that for the dollar, the logic of "inflation trade" and "Federal Reserve independence trade" is contradictory. On one hand, if inflation unexpectedly rises, prompting the Fed to respond more hawkishly and pushing up U.S. real interest rates, it would be favorable for the dollar. On the other hand, if the Fed becomes more dovish due to political pressure, leading to a relative decline in front-end rates, it would be unfavorable for the dollar.

From the position data, this divergence has led to a cautious market attitude.

According to data from the Commodity Futures Trading Commission (CFTC), after dollar short covering from July to August 5, this bullish momentum for the dollar abruptly halted after the announcement of Miran's nomination on August 7. Since then, the net short positions in dollar futures "have remained basically unchanged." This indicates that investors have not actively built positions on this theme before clarifying the direction of the dollar