Why Trump’s assault on Jerome Powell did not rattle markets

The statement from Fed Chairman Jerome Powell on Sunday night was remarkable and continues to resonate. The US Department of Justice — undoubtedly directed by the President — opened an investigation into the Chairman of the Federal Reserve in an attempt to coerce him into exiting the institution and giving the President full control over interest rates.

Perhaps it wasn’t designed just to intimidate Powell but whoever might come to replace him, or whoever might stand in the way. We’ve already seen signs of this as Fed Governor Kugler was chased out and Fed Governor Lisa Cook is under investigation for a trivial mortgage oversight, something the President has tried to fire her over. It will ultimately be decided by the Supreme Court.

This is all rightly setting off alarm bells everywhere and we’ve seen a spirited (and wise) defense of central bank independence from some Republican Senators who still have some integrity, along with past Fed Chairs and even right-wing media. I’m not going to go into the importance of central bank independence but it’s been well proven and allowing politicians to set rates has almost always ended in inflation.

So why wasn’t there a bigger market reaction in stock markets?

Maybe it’s because Trump looks like he will fail and that this will backfire, resulting in Powell digging in his heels and staying on the Fed as a Governor after his term ends.

I’d argue it’s equally because Trump might succeed in stacking the Fed with yes-men. That would result in interest rates lower than they should be and ultimately, inflation. But not inflation right away, at least not runaway inflation.

The real tail risk is that Trump succeeds in driving rates to 1% or 1.5%. It doesn’t take a long view of history to see what ultra-low rates do for the stock market. We saw it during covid and it was an absolute bonanza as it resulted in asset-price inflation that far exceeded real world inflation. It also allows market participants to indulge in their favourite pastime: leverage.

That’s the kind of thing that could wreck the bond market but stock markets are a great hedge against inflation.