Fed independence questioned as political pressure mounts

Renewed attacks on the Federal Reserve are unnerving investors and weighing on sentiment towards the dollar. President Trump’s call for Governor Lisa Cook to resign, citing allegations linked to past mortgages, has revived concerns over the central bank’s independence and added a fresh layer of political risk.

If Cook were to step aside, the balance within the Federal Open Market Committee could tilt more dovishly. Governors Waller and Bowman have already dissented in favour of rate cuts, while Stephen Miran — nominated as a temporary replacement for Adriana Kugler — is expected to back more aggressive easing if confirmed in September. Such a shift would amplify divisions within the Fed and add uncertainty to the policy outlook.

The dynamic is contributing to a steeper yield curve, with markets wary that prolonged political pressure could erode confidence in the institution. For the dollar, the risk is that credibility concerns resurface just as monetary easing expectations grow.

For now, the greenback has staged only a modest recovery this week, edging higher against a basket of peers. Today’s flash PMIs will provide a more immediate gauge of US economic momentum, while attention quickly turns to Chair Jerome Powell’s speech at Jackson Hole on Friday. His tone will be closely parsed for reassurance on Fed independence and clarity on policy direction.

Euro awaits PMI test

The euro has spent much of August in consolidation, with EUR/USD confined to a narrow range and volatility at multi-month lows. Despite a strong 12 per cent gain year-to-date, momentum has waned, with the pair anchored around its short-term moving averages.

Today’s flash PMIs could prove decisive. Investors are alert to signs that eurozone activity is faltering, particularly after the August ZEW survey showed German economic sentiment sliding sharply. Expectations dropped by 18 points, while the current conditions index sank further into negative territory, raising doubts about the strength of Europe’s recovery.

While any downside surprise in the PMIs may weigh on the euro in the near term, the broader FX story continues to revolve around relative growth. The currency’s earlier rally was supported by narrowing gaps between the eurozone and the US, and with signs of slowing US momentum, those differentials could once again turn in Europe’s favour. If fiscal support materialises later this year, the euro’s medium-term upside case may strengthen further.

Sterling vulnerable as real rates erode

Real interest rates in the UK have collapsed over the past twelve months, falling from a peak of 3.3 per cent in September 2024 to just 0.2 per cent today. With inflation running at 3.8 per cent and the Bank of England’s policy rate at 4 per cent, inflation-adjusted returns are barely positive.

The drop points to a loosening in financial conditions, despite the headline rate remaining high. It also raises doubts over whether policy is restrictive enough to tame demand and guide inflation back to target. With services inflation stubborn and 12-month expectations still around 4 per cent, the Bank’s decision to cut earlier this month is being questioned.

For sterling, lower real yields erode the relative appeal of UK assets, particularly against economies where inflation-adjusted rates remain comfortably positive. The FX options market may soon begin to reflect this vulnerability, with risk reversals skewing more negatively as investors seek protection against further downside.

Market pricing for another rate cut before year-end has slipped below 50 per cent, reflecting scepticism that the Bank can afford to ease again with inflation expected to peak at 4 per cent. Yet the stagflation risks are becoming more acute, leaving the BoE with little room to manoeuvre. In such an environment, GBP/USD may struggle to extend rallies, while GBP/EUR could remain rangebound.