Trump and the Federal Reserve's independence

Business Times

30-04-2025

PRESIDENT Donald Trump recently escalated his long-running attack on Federal Reserve chair Jerome Powell, lambasting him for keeping interest rates too high and accusing him of 'playing politics'. He lamented that 'Powell's termination cannot come fast enough!' and warned: 'If I want him out, he'll be out of there real fast, believe me.'
After a strong negative market reaction, the president backtracked, until further notice, and said he does not intend to fire the Fed chair. Such an attempt would test the legal safeguards that protect the Federal Reserve from political pressure and destabilise financial markets, as Treasury Secretary Scott Bessent reportedly warned Trump and the White House in private.
The legal background
The Federal Reserve Act sets clear limits: Under Title 12 of the United States Code paragraph 242, the president may remove a Fed governor or chair only 'for cause'. Courts have long held that 'cause' means misconduct or incapacity and does not apply to differing views on policy. This suggests that any attempt to dismiss Powell on those grounds would collapse under legal scrutiny.
Another safeguard of the Fed's independence is the 1935 Supreme Court decision in Humphrey's Executor v United States. That ruling established that Congress may insulate officials of independent agencies from removal except for 'inefficiency, neglect of duty, or malfeasance in office'. Fed governors and chairs have relied on this decision for protection.
However, Trump's legal team is seeking to strip similar 'for cause' protections from the National Labour Relations Board and the Merit Systems Protection Board. They argue the president cannot be constrained in shaping his executive team. The Supreme Court decisions on these cases could reshape the contours of agency independence, including that of the Federal Reserve.
That the Fed sets monetary policy independently has historically been a cornerstone of financial system stability. The US Congress granted the central bank this status to ensure that it could set policies affecting the economy and banking system free from political interference. Indeed, the financial community as well as members of both parties in Congress see an independent Fed as vital to preserving a strong economy.
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However, although the risk that Trump tries to fire Powell has now receded, during his four-year term, Trump and his team will have the possibility of increasing their influence on how the Fed sets US monetary policy.
Powell's term as Fed chair ends in May 2026. In the past, former Fed chairs stepped down from the position as Fed governors immediately or shortly after the end of their term as chair. If Powell resigns from the Fed, Trump will nominate one governor in his place, who would also be expected to become the new Fed chair.
Also, vice-chairs normally step down from their governor position after the end of their vice-chair term. Michael Barr resigned as vice-chair for supervision at the end of February 2025, and Trump nominated Governor Michelle Bowman in his place. It would not be surprising if Barr would soon also step down from his governor position, leaving another vacancy in the Fed board of governors for President Trump to fill.
In addition, Governor Adriana Kugler's term on the Fed's board expires at the end of January 2026, and Governor Philip Jefferon's term as vice-chair ends in September 2027. All in all, President Trump seems likely to have the chance to nominate four Fed governors, including the next chair and another vice-chair, before his presidential term ends in January 2029.
Likely market impact
Investors value stability and predictability highly. If Trump tried to fire Fed chair Powell, this would have likely prompted an even more violent reaction against US assets than was recently seen, encouraging money to flee abroad. Although less imminent, the risk remains that the Fed's anti-inflation credentials will be diminished under Trump's presidency.
Waning confidence in the Fed's resolve to curb inflation would lead bondholders to demand an increased risk premium to hold Treasuries, pushing up medium-to-long dated bond yields. As a counterexample of what could happen to bond yields if the Fed's independence is diminished is the market reaction to the Bank of England unexpectedly becoming independent in 1997. Several authors have documented how UK inflation expectations and bond yields fell, and long-term inflation expectations became less sensitive to the current state of the economy.
As short-term rates would be expected to be cut aggressively under a new Trump-appointed Fed leadership, the US yield curve would steepen dramatically, although that would not necessarily signal an improved growth outlook. Any attempt by the Fed under the new chair to limit the surge in yields, for instance by restarting quantitative easing, would likely be met with even stronger selling flows by private and international investors.
The US dollar would also be negatively impacted. Its role as the world's reserve currency rests on trust in US institutions. A politicised Fed would erode that trust. Foreign holders of US dollars will seek to diversify into other currencies and gold. The selloff in US government bonds would be mirrored by a sharp fall in the US dollar, compounding a trend that has already emerged after Trump's tariff announcements. In an adverse feedback loop, a weaker US dollar would eventually raise the price of imported goods, stoking inflation and inflation expectations and pushing bond yields higher.
Equity markets would not be spared the shock. Volatility would spike as investors price in the implications of a central bank subject to the will of the US president. An increased equity risk premium would depress US share prices and negatively affect their expected returns relative to other markets.
The writer is senior economist at EFG Asset Management