Trump Has Already Crossed Fed Independence Rubicon

Whether Federal Reserve Chair Jerome Powell is fired next week, forced to resign in six months or allowed to muddle through to the end of his term next May, the supposedly sacrosanct notion of Fed independence has already been shattered.

Yet what's nearly as remarkable as President Donald Trump's attacks on Powell for not cutting interest rates is financial markets' resilience in the face of this extraordinary degree of political interference in monetary policy, unprecedented in recent decades.

Equity investors are known for being optimists, but today's Wall Street is veritably Teflon-coated.

Of course, Trump's attacks on Powell have not been without consequence. The dollar has clocked its worst start to a year since the United States dropped the gold standard in the early 1970s. Long-dated Treasury yields are the highest in 20 years, and the "term premium" on U.S. debt is the highest in over a decade.

Consumers' inflation expectations, by some measures, are also the highest in decades. Inflation has been above the Fed's 2% target for over four years, and the prospect of a dovish Fed under the stewardship of a new Trump-friendly Chair could keep it that way.

But that's not solely down to Fed policy and credibility risks. The Trump administration's fiscal and trade policies, and unilateralist position on the world political stage, have also tempted some investors to trim their exposure to U.S. debt and the dollar.

Still, Wall Street seems immune to all that, and it closed in the green on Wednesday after Trump played down a Bloomberg report that he will soon fire Powell, a step he says is "highly unlikely". Even at the point of maximum selling before that rebuttal, the big U.S. equity indices were down less than 1%.

Given the magnitude of the news investors were reacting to, that's barely a ripple, especially when you remember that the S&P 500 and Nasdaq hit record highs only 24 hours earlier.

Indeed, the S&P 500 is enjoying its third-fastest rebound from a 20% drawdown in history, according to Fidelity's Jurrien Timmer. Goldman Sachs analysts also note that the index's price-to-earnings ratio of 22 times forward earnings is in the 97th percentile since 1980. And the Nasdaq is up 40% in barely three months.

Taking all this into account, there's plenty of space for a correction. What's needed is a catalyst. Threatening the foundation of the financial system would seem to qualify, but will it?

Thomson ReutersPolymarket betting probability of Fed's Powell out this year

BECOMING IMMUNE

One might argue that investors are simply skeptical that Trump really will oust Powell, even were it "for cause", ostensibly the Trump administration's ire over the $2.4 billion cost of renovating the Fed's building in Washington.

But Trump has made it clear for months that he wants Powell replaced by someone more malleable, so whether it happens in the coming weeks, months, or May next year, the new Fed Chair will almost certainly be someone strongly influenced by the president.

Of course, the Fed Chair is only one of 19 members of the Federal Open Market Committee and just one of 12 voting members at any given rate-setting meeting. He or she does not decide policy unilaterally. Still, the negative reaction to Powell leaving before his term is up could be powerful, even though you would expect it to be priced in to some extent by now.

All else being equal, a more dovish-leaning Fed will reasonably be expected to weigh on short-dated yields, steepen the yield curve, and weaken the dollar as bond investors price in more rate cuts, and keep inflation closer to 3% than 2%. In the short term, stocks could benefit from expectations of a lower policy rate, although higher long-dated yields would increase the discount rate, which could be particularly negative for Big Tech and other growth stocks.

JP Morgan CEO Jamie Dimon on Tuesday warned of the dangers of political interference in Fed policymaking, telling reporters on a conference call: "The independence of the Fed is absolutely critical. Playing around with the Fed can often have adverse consequences, absolutely opposite of what you might be hoping for."

That Rubicon has already been crossed, and for now at least, markets appear to have accepted that.

Source: Reuters