Powell Ouster Threat Boosts Bond Market’s ‘Cleanest’ Trade

President Donald Trump and Federal Reserve Chair Jerome Powell. (Getty Images)

President Donald Trump’s effort to drive short-term interest rates lower is prompting traders to bet that the yield curve will steepen.

A steepening yield curve occurs when the difference between longer-term and shorter-term bond yields grows. Investors got a sneak peek of it working on Wednesday when a perceived threat to Fed’s independence shot the difference in yields between five-year and 30-year above 100 basis points.

Trump later quelled those fears by calling Fed Chair Jerome Powell’s firing ‘highly unlikely,’ yet the spread between the two Treasuries settled at 103 basis points on Tuesday, close to its widest spread in years. (100 basis points equals one percentage point). The market is quite aware that Powell’s term as Fed chair ends next year, even if Trump doesn’t try to push him out sooner.

The rationale behind this steepening is simple: Shorter-end yields are getting pushed lower as investors see Powell’s replacement likely to cut rates sooner and faster. And investors are demanding more yield for longer-duration Treasuries to compensate for the risk of a Fed more submissive to Trump and less concerned about resurgent inflation, especially amid the tariff uncertainty.

The “U.S. administration is hellbent on controlling the monetary policies of the Fed by 2026. If it is successful, the cleanest trade would be to bet on a steepening of the US yield curve at its most extreme points—i.e., 30 years on the far end, vs. 6 months or one year at the front end,” wrote Macquarie strategist Thierry Wizman.

Other points on the yield curve also are steepening. The spread between the 10-year and 30-year, currently at 56.5 basis points, is close to its widest spread since 2021. The 10-year and five-year spread at 46 basis points was also close to its recent peak of 47 basis points on July 18, which at the time was the highest since 2021.

To do a steepening trade, an investor might short—or borrow with expectation to sell back at a lower price—contracts of 10-year Treasury futures and might buy two-year Treasury note futures. The bet isn’t on the outright levels of yields, rather the difference in yields. This strategy is risky and will profit only if the spread increases.

One problem with the yield curve steepener trade is that it is dependent on the whims of the Washington. On Tuesday, Trump told reporters that Powell has “done a bad job” but in “eight months he’ll be out” anyway—a toned down rhetoric suggesting Powell might serve his term until May.

Meanwhile, the White house’s criticism of the Fed has broadened with the Treasury Secretary Scott Bessent asking for a review of the Fed’s operations. Other conservative Trump allies have also made calls on X for his ouster.

“We do not favor being exposed to the Powell transition steepening risk,” Guneet Dhingra, head of U.S. rates strategy at BNP Paribas, said in a note this morning. He likes exposure to Treasury bills, which are shorter-dated debt that have been offering an attractive 4% yield.

Still, curves could steepen even if Powell stays on as chair. The market is looking for indications that political considerations are affecting the Fed Open Market Committee as key officials there appear to take optimistic view on rate cuts. If markets believe that monetary policymakers are trying to stimulate the economy through rate cuts even when it is inappropriate from a longer-run perspective, it would push inflation expectations higher—and along with it yield curve steepens.

“The July FOMC meeting on 30 July will be an acid test of whether the Fed will show concern vis-à-vis the recent worrying signs of inflation, or take a benign view by calling it “transitory”—which might lend credibility to recent rising concerns among investors that the Fed has
been “politicized,” Dhingra wrote.

It is hard to know where this could go. “There doesn’t appear to be much historical precedent for determining the boundaries of a “for cause” removal of the director of an independent agency,” Michael Feroli, chief U.S. economist at J.P. Morgan, wrote.

But if you believe it isn’t headed to a good place, take the steep road.

“We continue to see a steepener as among the best ways to play the unrelenting pressure on the Fed to abandon its price stability mandate,” Wizman wrote.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.