Markets are the casualty of Donald Trump's war on Federal Reserve

Times

8 hours ago

An increasingly familiar scenario unfolded once again last week between Donald Trump and Jerome Powell, chair of the US Federal Reserve. First, a salvo of insults, coupled with the suggestion that firing Powell could potentially be on the table. Next, a predictably poor response from bond markets and the dollar while the Fed chief maintains the silent stoicism of Clint Eastwood's Man With No Name. Finally, a denial by the president that he was ever considering removing him.
Because there is a circular, Groundhog Day quality to the recurring events, it's tempting to treat them less seriously than they should be. While actually ousting Powell could create a market explosion that would reverberate globally, the pattern of threat followed by backtrack is becoming established and, after a brief surge in volatility, markets calm down fairly quickly.
In essence, we end up where we began. No harm, no foul?
Unfortunately, this misses the point. Although we are unlikely to see the dramatic market reaction that would accompany forcibly removing Powell as Fed chair, the damage has nevertheless already been done. Repeated attacks on the US central bank — however ineffective as a catalyst for change — have eroded its credibility, at least for now.
Fairly or unfairly, every Fed ruling in the near term will be accompanied by investor questions about its rationale. They might ask whether a future decision to cut interest rates is based purely on impartial economic judgment, or whether the bank's Federal Open Market Committee (FOMC) has been influenced by political pressure. Or, if the Fed holds rates, whether this owes more to the desire to underline its independence than to making the economically correct call.
This affects markets — and specifically, the cost of US debt. Uncertainty among investors about what the Fed is thinking, and why, ultimately leads to them demanding a higher return from their bonds in exchange for the elevated risk. In short, the lower the credibility of the central bank, the more expensive it becomes to borrow.
Consider, too, that currently the data coming out of the US doesn't tell a clear story. Soft data, such as sentiment surveys, paints a gloomy picture, whereas hard data, such as retail sales and industrial production, is holding up. Jobs numbers, meanwhile, now come with the added variable of mass deportations to factor in. And with the latest tariff deadline scheduled for August 1, and the promise of secondary tariffs on anyone trading with Russia unless Putin agrees to a ceasefire with Ukraine, I can't think of a time when it has been harder to read the economic tea leaves — and, therefore, to fully understand the drivers of Fed action.
Whatever choices the FOMC makes, they won't be clear-cut, nor will the verdict be unanimous, leaving greater scope for questions over its decisions and motivations.
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If there is greater scrutiny of the Fed's judgment now, imagine what it will be like when Powell's term ends in May 2026 and he's eventually replaced. The new chair, whoever they are and whatever their credentials, will at least initially be regarded as somewhat politicised. For investors, this attaches a risk premium to US debt that didn't exist before. Market confidence will depend on the incoming candidate proving from the outset their imperviousness to political influence.
The net effect of undermining the Fed is diminished effectiveness of what is known as 'the monetary transition mechanism' — that is, how effectively central bank policy changes feed through to the broader economy and, ultimately, inflation. If its independence continues to be questioned, future Fed interest rate cuts are unlikely to generate the same level of bond yield reductions that we've come to expect.
Consequently, the irony of the president's continued demands on the Fed to lower rates is that, when it finally does, it may not have the desired impact.
In a week when the Congressional Budget Office provided an additional estimate indicating that the Big Beautiful Bill could add $3.4 trillion to the national debt, this would hardly be a welcome outcome for the White House.
On Thursday, Trump made the first in-person visit of a president to the Federal Reserve in 18 years. It was interpreted as another effort to crank up the pressure and followed his assessment earlier in the week that Powell is doing a 'terrible job'. The regularity of such broadsides, and the knock-on impact they've had on the way in which investors view the Fed, have made it nearly impossible for his eventual successor to do a more effective one.
Seema Shah is chief global strategist at Principal Asset Management