The last On Global Markets column looked at Chairman Powell’s remarks to the Jackson Hole gathering of central bankers and considered how the Federal Reserve was navigating the tough combination of a seemingly slowing economy coupled with tariff-driven price pressures. It closed by casting forwards and noting that a Fed Board reshaped by the current President may have different concerns.
What does seem likely is that in twelve months’ time the Fed’s board will have been gradually reshaped to bear more of the stamp of the current President. Such a board may not be able to display the same level-headedness in dealing with a complex economic situation. The real challenge for US monetary policy is not managing a tricky economy over the coming months, but managing even more complicated politics over the coming years.
This week, at least in terms of commentary if not really in market price moves, those fears came to a head.
President Trump announced on Monday that he was firing Fed Governor Lisa Cook from her position over alleged mortgage irregularities. The relationship between the Fed and White House has been acrimonious ever since the President took office but, until now, this has mostly been confined to words rather than actions.
Exactly how this will play out is now, in the short term, a matter for lawyers rather than economists. Governor Cook has pledged to resist the dismissal and her attorneys argue the President lacks the means to fire her.
However this plays out in the courts though, it is a big moment for the institutional structure of the Fed.
As Chris Giles put it in the Financial Times:
The case of one Fed governor is not that significant on its own. But it is no exaggeration to say that the Fed’s independence and role in the international financial system could hang on Cook’s fate and experience with US judges.
The Trump administration is reviewing options for exerting more influence over the Federal Reserve’s 12 regional banks that would potentially extend its reach beyond personnel appointments in Washington, according to people familiar with the matter.
Rabobank, quoted on the FT’s Alphaville blog, argue that this should be clearly seen as an attempted politicization of central banking.
The unabashed politicization of the supposedly independent and technocratic process of setting the price of money once again confirms that it is no longer the 1990s and that old ideas about optimal policy transmission, central bank credibility and the need to insulate important decisions from the influence of the popular will offers little protection against the new paradigm of raw power politics. Just as the interpretation of law is inherently political, the price of money is inherently political, and all aspects of national policy are being co-opted to support the MAGA vision of the United States and its place in the world.
To which one could easily add recent developments at the Bureau of Labor Statistics too.
All of these rapidly moving events raise questions, not least why is the President stepping up his attack on the Fed just at the time which the central bank seems to be moving towards the interest rates which he so obviously seeks?
More broadly, what exactly does the administration hope to achieve? It is not too hard to imagine a scenario in which, if the courts allow it, the President is able to fire enough governors and pack the board of the Fed with appointees prepared to put the needs of the electoral cycle ahead of that of managing the business cycle and cut policy rates faster than the macroeconomic situation warrants. But, in such a scenario, even if short term rates were cut, worries about faster inflation, lost credibility and worries about sustainability would all likely lead to pressure on longer term bonds. It is not hard to envisage a world in which the yield on policy-sensitive two year bonds fall while those on ten year and thirty year bonds rise sharply. Such a scenario would not help with government debt servicing costs and would bring real costs to households and firms.
Perhaps the biggest question, so far at least though, is why has the market reaction to the attempted firing been so muted?
The dollar took a small fall on the initial news and there has been some upward drift in longer term yields, but anyone glancing at the charts would struggle to spot a potential existential event for central bank independence in the price action so far.
It may be that eight months or so of volatile talk and policy action from the White House have left markets more determined to react to actual events than to price in risks. Perhaps it will take a firm court ruling to draw a real reaction?
But if financial market participants truly value central bank independence, it is they who are best placed to preserve it. An adverse market reaction is likely the best way to stay the President’s hand.
