Fed likely to become more politicized, dollar under pressure, gold to shine: UBS

Investing.com — President Donald Trump's move to dismiss Fed chief Lisa Cook has raised the risk of further politicization of the Federal Reserve in the next six to 12 months, according to UBS's latest report. This poses a threat of a further decline in the dollar and a rise below it.

“While political pressure could negatively impact long-term US government bonds, we continue to see value in high-quality and investment-grade bonds, particularly medium-term futures,” UBS economists said in their latest report. The U.S. dollar, already under pressure from expected Fed easing and mounting fiscal challenges, “could take another hit if the Fed's independence or credibility is undermined.” Gold, on the other hand, will benefit in an environment of continued uncertainty and falling real interest rates.

Trump's move to impeach Cook, citing allegations of mortgage fraud, has so far caused a limited reaction in the market in terms of concerns about the Fed's independence.

If Trump succeeds in ousting Cook, a voting member of the 12-member Federal Reserve Open Market Committee (FOMC), he will get the right to appoint a new member to the seven-person board that sets interest rates. This board is increasingly shifting to a dovish trend, that is, an attitude towards lowering interest rates.

This dovish trend was highlighted in Fed President Jerome Powell's recent speech in Jackson Hole, Wyoming.

Powell said in his statement at Jackson Hole: “Since policy is in restrictive territory, the fundamental outlook and the changing balance of risk may require us to adjust our policy stance.”

However, deep interest rate cuts are unlikely, according to UBS. “Unless the labor market deteriorates sharply, there may be some limits to how much policy can change.”

Meanwhile, the Fed's politicization could have far-reaching consequences for Trump's plan to reshape the central bank with potential unconventional candidates more suited to his political agenda.

The economists added: “We also note that any successor nominated to the Fed must be confirmed by the Senate; political attacks on the Fed's independence could jeopardize the passage of less orthodox nominees.”

While political intervention looms as a significant risk, investors face a delicate balance between the Fed's tasks and potential concessions to its independence. This will likely increase demand for safe-haven gold. According to UBS, gold will benefit from “continued uncertainty and low real interest rates” and set a target of $3,700 per ounce by the middle of next year.

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