President Donald Trump has been vocal in his criticism of US Federal Reserve Chair Jerome Powell for some time. Trump wants US interest rates cut significantly and has called for them to be reduced to 1.00% but Jerome Powell has held firm, and interest rates remain in a range of 4.25%-4.50%. Ordinarily, Trump would not hesitate to fire anyone who stands in the way of what he wants in place. But this situation is very different and there are significant implications for global financial markets, the US currency and its institutions if he oversteps.
For background, Powell was handpicked by Trump in 2017 and has served as Fed Chair since 2018. His second four-year term will end in May next year. There are two main concerns. The first is that there are real questions over whether Trump has the legal authority to fire the Chair of the Federal Reserve in the first place. More troubling for investors and global markets is the uncertainty of what comes next, as the Federal Reserve’s credibility hinges on its independence
If Trump removes Powell, especially over policy disagreements like interest rate decisions, it will set a dangerous precedent. Markets will begin to view future Fed decisions as politically motivated, not data driven. Future Fed Chairs aligning with political goals rather than long-term economic stability is a recipe for disaster. Central banks are independent precisely because it enables them to make the hard decisions needed to control inflation. If you undermine this independence, the result is likely long-term inflation fears and less effective monetary policy.
In many respects, this door has already been opened regardless of whether Trump fires Powell or not. There are reports that Trump may announce Powell’s successor much earlier than normal, perhaps in September, in a deliberate attempt to flag to markets that rates will be coming down. While Powell may or may not drop interest rates, it's clear that whoever Trump ultimately nominates will be chosen specifically because of their position that interest rates need to be much lower. The idea here is that markets being forward-looking will understand that, soon enough, low rates will be delivered.
The US has massive debt (over US$36 trillion) and deficits (around US$2 trillion annually). There are huge amounts of borrowing needed to fund the deficit and refinance maturing debt. It’s trillions of dollars each year, and interest costs are massive. Trump’s plan is for interest rates to be dramatically lower in the short term so that it’s cheaper for the US to borrow. In simple terms, that makes sense. But financial markets and the machinations of the economy are more complex than that.
The immediate concern if Trump fires Powell would be the destruction of the Fed’s perceived independence. However, the greater risk lies in the likely consequences: market instability, rising inflation expectations, a weaker dollar, and long-term damage to U.S. economic credibility. Even if short term interest rates fall, the unintended consequences would likely leave the US economy and financial system worse off. There would be lower global demand for US treasuries, and it would be detrimental to the US dollar as the world’s reserve currency.
Trump is going to get his way simply because he is relentless. But how he handles it will matter. Powell is under attack, and the campaign to remove him seems to be going into overdrive. They have called for his resignation, leaked reports that he will be fired, denied the reports and started an investigation in relation to mismanagement in relation to the renovations at the Federal Reserve building. This seems designed to break Powell and make him resign. This is clearly their preferred strategy over firing him, which would potentially create a legal and constitutional crisis that would have far reaching implications.
Yet for all the turmoil, markets seem to be taking everything in their stride. The US economy still appears to be strong. Employment numbers recently were solid, with unemployment lower than expected at 4.1% which is incredibly low. Inflation is in check, so far, but a spike from tariffs is coming. The irony of all this is that as it unfolds, equity markets are likely to initially rally at the prospect of a return to a lower interest rate environment in the next 12-18 months. However, that will soon be followed by fears that the inflation genie is once again out of the bottle, and this time it will not be so simple to fix.
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