As President Donald Trump jawbones the Federal Reserve, the likelihood that he’s going get what he wants this year from the central bank continues to grow.
Markets expect the Fed to hold off on rate hikes and are even anticipating the possibility of a cut during the next year or two, playing into the low-rate environment the president has espoused.
That in turn would decrease the chances that Trump might try to fire Fed Chairman Jerome Powell, a move universally regarded as difficult to achieve and likely disruptive if not disastrous for the market.
“Replacing Powell might prompt initial disruptions in markets. Reduced US central bank independence could lead to longer-term damage to the US economy,” Dana Peterson, North American economist for Citigroup, said in a note that called the threat of Powell getting ousted “deep within the realm of tail risks.”
That chance may have declined even more in recent days as market conditions improved and Powell in a public forum Friday provided assurance that the Fed will be “patient” in how it normalizes monetary policy, attentive to what the market is signaling, and flexible in how it proceeds with interest rates and its balance sheet reduction.
Trump nonetheless made it clear he’s still keeping an eye on things.
“Can you imagine if I had long term ZERO interest rates to play with like the past administration, rather than the rapidly raised normalized rates we have today,” the president said in his latest Fed-related tweet Tuesday.
Conditions indeed have changed.
Whereas the market — and Trump’s predecessor, Barack Obama — enjoyed for seven years the fruits of near-zero interest rates and quantitative easing that helped push the market up more than 300 percent, the current climate is one of rising rates and no Fed money-printing.
Rethinking rates and the balance sheet
As Trump pointed out, the market has gained substantially since his election, but the latest leg in the bull market was tempered by a sharp sell-off in the fourth quarter of 2018 spurred in part by fears of a Fed policy mistake.
Economists expect 2019 to feature the Fed rethinking its strategy on rate normalization as well its approach to reducing the size of the balance sheet bond portfolio by $50 billion a month.
Economists will get another look inside the policymaking Federal Open Market Committee’s thinking Wednesday when the minutes from December’s meeting are released at 2 p.m. ET. The FOMC approved a quarter-point rate hike at the meeting, the fourth of the year.
“If there were to be a sharp enough deterioration in the outlook that threatens outright recession, we think the Fed would pivot aggressively on both rates and balance sheet, cutting rates sharply and putting the balance sheet on hold,” wrote Krishna Guha, head of global policy and central bank strategy at Evercore ISI.
One difference he sees is the Fed making more use of forward guidance on its intentions than on the massive bond purchases it conducted during the three rounds of QE. Powell in the past has voiced skepticism about the balance sheet expansion and has said he doubts the monthly roll-off of bond proceeds would be interrupted unless conditions change notably. The balance sheet has been reduced by about $400 billion.
The market is firm in its view as well: Traders are pricing in virtually no chance of a rate hike this year and in fact are now starting to view a cut as more likely heading into 2020-21. In the chart below, the fed funds futures curve rises as the settlement price gets higher, indicating a lower funds rate. The terminal date on the chart is Dec. 31, 2021.
Firing without ’cause’
All of that might mollify Trump, though questions remain about whether he would try to remove Powell should the Fed not do as the president likes.
In Wall Street’s view, Trump may have the authority to remove the Fed chair for “cause” but likely would have a hard time proving his case just because he doesn’t like where interest rates are heading.
“Removing Powell for ’cause’ likely would involve a series of lawsuits without timely resolutions,” Citigroup’s Peterson said. “Indeed, President Trump would have to prove that Powell should be removed for ’cause,’ in which legal precedent alludes to dereliction of duty, moral turpitude, physical or mental incapacity, or similar failings that demonstrate an unfitness for the office, not disagreement over policy.”
As a practical matter, removing Powell wouldn’t guarantee Trump a Fed reluctant to hike rates.
Of the remaining group, only St. Louis President James Bullard has professed a strong commitment to pausing on rate hikes.
“Even if Trump succeeded in having a dovish Powell replacement confirmed by the Senate, the new Chair of the Fed Board would hold only one vote on the FOMC, meaning he or she could easily be out-voted by the other Fed Governors and voting regional Fed Presidents,” Paul Ashworth, chief U.S. economist at Capital Economics, said in a note. “Trump could escalate the fight by dismissing the remaining four Fed Board Governors. But replacing them would require finding another four candidates willing to act as political stooges, and then getting those nominees confirmed by the Senate.”
Ashworth said the bigger risk is that Trump might take out his anger at Powell on Treasury Secretary Steven Mnuchin, who backed Powell’s appointment.
Doing so would be disruptive as Mnuchin has been a leader in the U.S.-China trade talks. The departure of Mnuchin, Ashworth argued, would be more significant for markets than even replacing Powell.