Federal Reserve

If Trump shakes up the Fed, monetary policy won't be the same for the next 10 years: Deutsche Bank

Janet Yellen
Samuel Corum | Anadolu Agency | Getty Images

U.S. President Donald Trump could dramatically revise the Federal Reserve's monetary policy outlook over the next 10 years after he signaled a possible retreat from a strong dollar policy, according to a Deutsche Bank report.

The U.S. President told a group of pharmaceutical chief executives Tuesday that countries such as China, Japan and Germany had deliberately weakened their currencies to make their imports cheaper and gain a trade advantage over the U.S.

Although the allegations were subsequently rejected by the countries, Trump's remarks appeared to suggest he would favor a weaker dollar. And this could guide his hand in making key governor appointments at the U.S. central bank.

Appointments determine "dollar policy"

The Fed currently has two governor vacancies, potentially three more in the pipeline and the central bank's Chair, Janet Yellen, is due to step down in February 2018. Trump is responsible for replacing all of these key posts and Deutsche Bank assessed the three potential outcomes of such a shake-up in a report published on Wednesday.

"First, Trump's Fed appointments will ultimately determine the fate of 'dollar policy' this year. For all the attention on recent comments on exchange rates, a Trump Fed's hawkish or dovish leanings will matter much more," George Saravelos, strategist at Deutsche Bank, said in a note.

"Second, news on Fed appointments could come quicker than the market assumes. Now that the Supreme Court nomination is out of the way, the Fed may be next. The next Fed Chair could easily be placed in one of the two vacant seats even if a chairmanship appointment is left for later," he added.

Dovish governors do not guarantee low rates

Trump has said he would most likely replace Yellen when her term of office expires in February 2018. Yellen has so far steered clear of a public feud with the President, in spite of Trump alleging during one of the presidential debates that she had deliberately kept interest rates low in order to boost Hilary Clinton's chances of an election victory.

"Third, a dovish Fed does not mean lower U.S. Treasury (UST) yields. If under Trump the Fed turns extremely dovish, credibility is lost, inflation expectations spike, UST yields rise and the dollar weakens. If Trump wants a soft dollar he needs to make dovish appointments; but that will not necessarily guarantee low rates," the report said.

The Federal Open Market Committee is scheduled Wednesday to make it first rate decision since the new administration took office. The U.S. central bank has forecast three rate rises in 2017, however investors do not expect a rate hike so early in the year.