US Fed reform may move markets more than Powell ouster

New Straits Times

2 days ago

LONDON: Changing the way the Federal Reserve operates or assesses the economy may have a more durable impact on policy and markets than firing the Fed boss.
US Treasury Secretary Scott Bessent added another twist to President Donald Trump's ongoing criticism of Fed Chair Jerome Powell on Monday by claiming he wanted to review the entire Fed institution and its performance.
In an interview with CNBC, Bessent claimed the Fed's "fear-mongering over tariffs" without significant signs of inflation was justification for considering a root-and-branch review of the central bank's functioning.
"What we need to do is examine the entire Federal Reserve institution and whether they have been successful," he said. "All these PhDs over there, I don't know what they do."
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It's not yet clear whether Bessent was merely heaping more pressure on the Fed to speed up interest rate cuts, as Trump has been demanding almost daily, or whether the administration is actually planning to conduct a formal review of Fed operations, analysis and execution.
While recent weeks have been filled with anxious noise about Trump attempting to fire Powell, this latest development - possible changes to the way the Fed ticks - could be much more far-reaching and impactful than simply truncating the tenure of one Chair.
Of course, the Fed Chair is an important role, and a politically motivated ouster would be a serious challenge to Fed independence. Yet the Fed boss ultimately remains just one vote on the rate-setting board, and the Fed's policymaking structure is partly designed to insulate the central bank from any undue political influence.
The Federal Open Market Committee that sets policy is made up of seven Fed board members and five regional Fed bosses, but the FOMC chair and vice chair are voted in by the committee at the start of each year. The Fed Chair typically takes the helm by convention, but not necessity.
If a majority of the FOMC members balked at a politically partisan appointee to the top job, they could theoretically vote for a different Chair of the FOMC in an act of defiance.
But, regardless, the Chair is still only one vote.
PRICE TOO HIGH
Changing the Fed's institutional structure would require Congressional approval, a process likely to be protracted as many Republicans, including strong Trump supporters, may be wary of tampering with the Fed.
Moreover, a recent Supreme Court ruling also suggested Fed structures should be left in place due to "a special historical status."
But influencing the way the Fed thinks, forecasts and operates is a different matter.
To complicate matters further, the Wall Street Journal on Monday claimed Bessent counseled Trump against firing Powell, arguing that the current Fed Chair might sue, or Congress could drag its feet on approving a replacement.
Both scenarios could result in a leadership hiatus that would see Joe Biden appointee Vice Fed Chair Philip Jefferson assume the role.
Bessent argued the price of removing Powell now was potential market disruption and economic uncertainty for no real gain in influence compared with waiting for Powell's term to just expire in May, the WSJ said.
Trump, already battling with the WSJ on another story, dismissed the report as 'fake'. Bessent said the decision was ultimately up to Trump. But the messiness of Powell's removal may be why the administration sees other pressure on the Fed to buckle on rates soon as more fruitful.
After all, two Trump appointees to the board - Christopher Waller and Michelle Bowman - already arguing for immediate cuts and two more board positions, including Powell's, are likely to come up by this time next year.
That would leave a majority on the board being Trump appointees - even though not the FOMC. SGH Macro Advisors' Tim Duy reckons that to reshape the Fed, the White House needs even more seats to shift the board - building a block of Trump nominees sufficient to out-vote the five regional Presidents that make up the rest of the FOMC.
Without that, it leaves the Trump team trying to change the DNA of Fed thinking and a major review that shifts standing assumptions, forecasting patterns and public presentations may be significant longer-term.
Current favorite to be Trump's pick for the Chair, former Fed policymaker Kevin Warsh, who is a known critic of orthodox Fed analysis, doubts there's a trade-off between jobs and inflation the way it's currently presented and claims rates can move lower if balance sheet policies were tighter.
If markets think it's inappropriate to ease now, of course, then inflation expectations may just build on fears of undue political influence and long-term borrowing rates should rise.
But it may not be that clean. "The goal appears to be to keep policy rates low while shifting US Treasury issuance to the front end of the curve," wrote SGH Macro's Duy.
"While excessively loose policy would be expected to raise long term rates, there is the possibility that Fed and Treasury manage the debt with an eye toward yield curve control."
That's a delicate balance that might come off - but guaranteeing the Fed comes on board will not be easy.