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Source: morningstar

A Department of Justice criminal investigation into Federal Reserve Chair Jerome Powell's testimony is creating new risks for U.S. monetary policy, according to an analysis by Bank of America. While the development introduces a fresh layer of uncertainty, markets have so far absorbed the news without significant volatility.

Markets Remain Calm Despite Investigation

Bank of America economist Aditya Bhave noted that markets have "essentially looked through the news." The 30-year Treasury yield, a key indicator of market sentiment on long-term Fed policy, rose by only about 2 basis points. Bhave pointed out that such a move is minimal compared to what might typically express "concerns about Fed independence."

This muted reaction stands in stark contrast to market behavior last summer. When then-President Trump hinted he might remove Powell from his post, the 30-year yield saw a much sharper response. According to BofA, the yield jumped 8 basis points on July 11 and another 11 basis points during intraday trading on July 16 before pulling back.

Shifting Odds on Powell's Future at the Fed

Powell’s own firm response to recent speculation may have altered investor expectations about his tenure. BofA analysts believe his actions have increased the perceived probability that he will remain on the Fed Board as a Governor even after his term as chair concludes in May.

Citing data from Polymarket, the bank highlighted that the probability of Powell leaving the board by the end of the year has dropped from 83% to 57%.

New Headwinds for Monetary Policy

Despite the market's calm, Bhave warned that the investigation could have significant policy implications. The situation "might also galvanize the hawks on the FOMC," making it more challenging for a future, more dovish Fed chair to justify rate cuts based purely on economic data.

Looking ahead, Bank of America suggested that a separate event has become even more critical for the Fed's future. The Supreme Court's hearing on Governor Lisa Cook's case, scheduled for January 21, is now viewed as "more important for the policy trajectory than the identity of the next Fed Chair." A ruling against Cook, the bank concluded, would "significantly raise the probability" that Powell could also face removal.

The era of synchronized monetary policy is ending. After years of moving in lockstep to combat post-pandemic inflation, the world's major central banks are now entering a period of significant divergence, creating a complex and uncertain outlook for the global economy.

According to forecasts from Bloomberg Economics, the next year will see a wide spectrum of interest rate policies across advanced economies as central bankers navigate mixed economic signals and rising political volatility, particularly from the United States.

The Federal Reserve: A Lone Path to Easing?

All eyes are on the U.S. Federal Reserve, which faces a unique set of challenges. Policymakers must interpret conflicting economic data while contending with the potential for a new chair appointed by a president openly demanding rate cuts and applying legal pressure on the institution.

Bloomberg Economics projects the Fed will ease more aggressively than the market consensus, which currently anticipates just two cuts in 2026. This view is based on the expectation that a weakening labor market will soften the Fed's hawkish stance.

Jamie Rush, director of global economics at Bloomberg Economics, notes that this U.S. policy shift won't be mirrored elsewhere. "The world's most important central bank is likely to cut by more than markets expect," he said. "Deep U.S. rate cuts won't be replicated by other major central banks."

A Fragmented Global Policy Landscape

Stripping out the U.S., the combined interest rate gauge for advanced economies is expected to end the year with little change, highlighting the growing split in policy trajectories. The forecast for key central banks reveals a fractured approach:

• Bank of England (BOE): Expected to cut rates far less than the Fed.

• European Central Bank (ECB): Believed to be finished with its rate-cutting cycle.

• Bank of Japan (BOJ): Moving in the opposite direction, toward tightening.

• Potential Hikes: Canada, Japan, and Switzerland may see rate increases.

• Holding Steady: The euro zone is projected to keep borrowing costs stable.

• Further Cuts: Australia and New Zealand are likely to lower rates.

Meanwhile, central banks in emerging markets from Brazil to Nigeria are expected to implement significant rate reductions. Geopolitics, trade disputes, and political developments in the U.S. remain key variables that could easily disrupt these forecasts.

Is the US Productivity Surge a Statistical Mirage?

While monetary policy is a key focus, a debate is also brewing over the strength of the U.S. economy itself. Official data showed U.S. productivity growth accelerating to annualized rates of 4.1% and 4.9% in the second and third quarters of last year, sparking talk of an AI-driven boom.

However, Neil Dutta, head of economic research at Renaissance Macro, urges caution. He argues that productivity is a "residual" figure derived from GDP growth and total hours worked. Since GDP appeared to jump in mid-2025 while payroll growth slowed and work hours stagnated, productivity automatically surged in the data. Dutta suspects the GDP figure may be overstated.

He points to two reasons for his skepticism. First, genuine productivity booms are typically accompanied by strong growth in real, inflation-adjusted incomes, which is not currently happening. Second, major technological investments usually take time to translate into productivity gains, suggesting it may be too early to see an AI-driven surge.

Dutta's conclusion is that observers "are conflating a short-run data disconnect with a longer-run productivity story."

Crude oil prices are climbing as widespread civil unrest in Iran fuels market fears of a major disruption to global energy supplies. The instability has pushed both major benchmarks to multi-week highs.

By 06:50 ET (11:50 GMT), Brent futures had gained 1.9%, trading at $65.08 a barrel and nearing a two-month peak. U.S. West Texas Intermediate (WTI) crude saw a more significant jump, rising 2.4% to $60.74, its highest level since December 8.

Protests Deepen Across Iran

The primary driver behind the market's bullish sentiment is the escalating wave of anti-government demonstrations across Iran, one of OPEC's largest oil producers.

According to a note from BCA Research dated January 12, the current protests have already surpassed the 2019-20 demonstrations in scale and are approaching the size of the 2022-23 unrest. The firm expects the situation to worsen for two main reasons:

• Loss of Credibility: The Iranian regime has lost significant credibility with the public over the past decade.

• Leadership Succession: Opposition forces sense a rare opportunity to gain influence during the impending leadership transition from Supreme Leader Ali Khamenei.

Geopolitical Tensions Flare

As the protests expand across different social classes and geographic regions, both Iran and the United States have started exchanging military threats, raising the stakes.

While Iran's typical response to mass protests is violent repression, the U.S. recently warned the country against using force and stated it would "rescue" any protesters harmed by the regime. In turn, Iran threatened to target U.S. bases and regional shipping lanes if it faced action from the U.S. or Israel.

BCA Warns of 40% Risk of Oil Supply Shock

This mounting instability, which poses a risk to the Iranian regime's survival, has direct implications for the global oil market.

BCA Research now estimates that the probability of a "massive global oil supply shock" has returned to around 40%, a level it had assigned to the risk last year. The analysis highlights how closely traders are watching the domestic situation in Iran for signs of a potential supply interruption.

After a quarter-century of talks, the European Union and South America's Mercosur bloc have finalized a landmark trade agreement. The deal substantially boosts economic ties between the EU and Mercosur's members—Brazil, Argentina, Paraguay, and Uruguay—but its significance extends far beyond commerce. According to officials and analysts, the pact may reveal the limits of the Trump administration's pressure tactics in a region where U.S. influence has waned as China's has grown.

French farmers protest the EU-Mercosur trade agreement in Paris, highlighting the domestic challenges facing the landmark deal.

Did Trump's Foreign Policy Accelerate the Pact?

While South American governments are unlikely to abandon strengthening ties with China or Europe, some analysts believe President Donald Trump's efforts to flex American power may have inadvertently pushed the long-delayed EU-Mercosur agreement across the finish line.

"If credit for this deal goes to anyone, it is to the international context," said Ignacio Bartesaghi, a foreign policy adviser to multiple Uruguayan governments. "It goes to Trump's tariff war, the conflict in Ukraine, to what happened in Venezuela recently."

The Trump administration has recently employed several high-pressure strategies in the region. These include a commando raid to seize Venezuelan President Nicolas Maduro and threats to cut financial support to Honduras if a specific candidate did not win the presidential election. The administration also conditioned billions in loans to Argentina on a conservative victory in the country's midterms and used steep tariffs to pressure Brazil regarding the prosecution of former President Jair Bolsonaro, a Trump ally.

Though voters sided with Trump's preferred candidates in Honduras and Argentina, Bolsonaro was later convicted, and the U.S. eventually dropped most of the new tariffs on Brazilian goods.

The White House maintains its approach has been successful. "The return of America's pre-eminence in the Western Hemisphere, led by President Trump, is undisputed," said spokeswoman Anna Kelly. "All of the President's foreign policy actions have restored American strength after four years of weakness under Joe Biden."

Latin America Recommits to Multilateralism

Despite Washington's focus on unilateral action, few countries in Latin America appear to share the sentiment. Trump has openly criticized multilateralism, withdrawn the U.S. from several global pacts, and told The New York Times he did not need "international law."

In contrast, leaders in the region are championing rule-based international order. Even Argentine President Javier Milei, one of Trump's closest regional allies, celebrated the EU deal as a victory for "clear rules and freedom," despite also praising the U.S.-backed capture of Maduro.

A Brazilian official close to the presidency described the agreement as a "breath of fresh air" during what they called "the most shameful and negatively critical week for multilateralism in decades." The deal's finalization comes after Venezuela, a former full member, was suspended from Mercosur in 2016 for failing to meet trade and human rights standards.

A New Wave of Global Trade Deals

The EU-Mercosur agreement could be just the beginning. Welber Barral, a former Brazilian trade secretary, suggested it may encourage Mercosur to conclude other trade pacts with partners like Canada and the United Arab Emirates.

"Countries are seeking to create regional rules that can be obeyed, so they won't depend on the World Trade Organization, which is being discredited by Trump," Barral said.

This trend is not isolated to South America. Other nations hit with steep tariffs by the Trump administration are also forging new alliances. Indonesia secured a trade accord with the European Union, while Japan, South Korea, and China have pledged to increase regional trade.

Margaret Myers, director of the Asia & Latin America Program at the Inter-American Dialogue, said the deal between Europe and South America shows that many countries are committed to reinforcing global norms.

"At a time when the U.S. is breaking from the status quo, parts of Latin America appear to be upholding it," she said. "It's a wake-up call for the U.S."

A plunging yen combined with surging government bond yields has many market watchers on edge. But according to the Carlyle Group Inc., these trends are positive indicators that Japan is finally breaking free from decades of deflation.

In a recent outlook, Jason Thomas, Carlyle's head of global research and investment strategy, argued that observers are misinterpreting key market signals. The firm's analysis suggests that Japan's current economic state is one of normalization, not crisis.

The Case for Optimism

Carlyle's central argument is that the combination of rising interest rates and a weaker currency is a feature, not a bug, of Japan's economic recovery. Thomas and his team highlight that a more competitive yen directly boosts the profits of domestic businesses.

"There's nothing alarming about the normalization of interest rates in an economy that's finally exited convalescence from its deflationary slump," Thomas stated. "Don't misread market signals."

This perspective pushes back against the growing concern over the yen's sustained weakness, which recently hit a yearly low of around 158 per dollar. At the same time, yields on Japan's benchmark 10-year government bond have climbed 100 basis points over the past year to approximately 2.10%, the highest they have been since the late 1990s.

The Bank of Japan's Deliberate Pace

Under the leadership of Governor Kazuo Ueda, the Bank of Japan (BOJ) has charted a course of steady monetary tightening, a stark contrast to the policies of other major central banks in 2025. The BOJ increased borrowing costs twice last year, and traders are pricing in about 50 basis points of additional hikes by the end of 2026, according to Bloomberg data.

Despite this methodical approach, Japan's 10-year bond yields remain significantly lower than those of its major peers, especially the United States. This wide differential in real interest rates continues to put downward pressure on the yen.

Critics have called the BOJ's pace "glacial," but Thomas defends the central bank's caution. "After 20 years of deflation, some charity is warranted," he said in an interview, noting the "understandable degree of caution."

Debunking the Public Debt Narrative

Concerns about Japan's public finances have also intensified, particularly after the October election of Prime Minister Sanae Takaichi. Her government is preparing a record initial budget of ¥122.3 trillion (approximately $775 billion) for the fiscal year starting in April.

While Japan's public debt is often cited as the highest among major economies, Thomas and his team argue that simple country-by-country comparisons are misleading. Carlyle points to a 2025 study from the Federal Reserve Bank of St. Louis, which presents a different picture.

The study shows that when Japan's government investment portfolios—specifically the Fiscal Investment and Loan Program—are included in the calculation, the country's net liabilities are closer to 80% of its gross domestic product. This figure is substantially lower than that of the US.

"For my entire career, people have fretted about Japan," Thomas concluded. "Many people who have been wrong about Japan for a long time now see a new opening."