Is the Federal Reserve's independence in jeopardy? Criminal investigations might actually raise interest rate expectations

UBS Chief Economist Paul Donovan recently proposed an interesting paradox: a criminal investigation into the Federal Reserve Chair could ultimately strengthen the central bank’s independence and thereby push up market expectations for interest rates. This reflects deep market concerns about the political independence of the Fed and how such worries influence monetary policy directions.

The Federal Reserve’s Independence Under Test

Donovan pointed out that market reactions have already clearly shown investor concerns. Although overall asset prices have not fluctuated significantly, key indicators have reflected the market’s true sentiment:

• Long-term US Treasury yields rising
• US dollar weakening

These two signals seem contradictory but actually point to the same issue: a decline in market confidence in the Fed’s ability to manage interest rates without political interference. Rising Treasury yields mean investors demand higher risk premiums, while a weaker dollar reflects concerns over US policy stability.

Chain Reactions Triggered by Policy Uncertainty

Powell’s Tough Stance

Donovan believes that Powell’s firm stance in the face of criminal investigations may have two implications:

First, he is unwilling to resign from his Federal Reserve Board position in 2026, indicating a firm hold on his role, which in some ways also serves to defend the central bank’s independence. Second, this stance may itself reinforce market expectations that the Fed will adopt a more hawkish stance—a central banker unwilling to yield to political pressure is more likely to stick to tightening policies.

Delay in Chair Nomination

Meanwhile, the US Senate may delay confirming the new Fed Chair nomination. Such delays create policy uncertainty, and when markets face uncertainty, they tend to price in higher risk premiums.

Concerns Over Central Bank Independence Turn into Hawkish Power

This is the most critical insight in Donovan’s view: worries about the independence of the central bank could translate into a hawkish influence on future monetary policy decisions.

In other words, to preserve independence, the Fed might be forced to adopt more conservative and hawkish policy stances. This creates an irony: the threat of political interference actually pushes the central bank toward tighter policies.

Connection to Inflation Expectations

This view echoes recent predictions by Bill Ackman, CEO of Pershing Square Capital Management. Ackman stated that the Fed might abandon its 2% inflation target and instead set a target range of 2.5%-3%.

If the Fed indeed raises its inflation tolerance, it could be a forced compromise under political pressure. However, in the name of maintaining independence, the Fed might offset this compromise by adopting more hawkish interest rate policies.

Key Points Investors Should Watch

Summary

UBS Chief Economist’s perspective reveals a deep market logic: when facing threats of political interference, the Fed may be compelled to adopt more hawkish policies to safeguard independence. This could severely limit the Fed’s room to cut rates in 2026 and might even lead to sustained high interest rates.

Market has already responded with rising Treasury yields and a weakening dollar. For investors, it is crucial to recognize this political-economic interaction and adjust expectations for the Fed’s policy trajectory accordingly. In the short term, concerns over central bank independence will continue to support higher Treasury yields; in the medium term, this could lead to a much tighter global liquidity environment than the market anticipates.