Fed refuses to bow to the President’s dictates

US President Donald Trump has sharpened his criticism of the Fed’s monetary policy orientation. After initially saying only that he was unhappy with Fed policy, he went on to raise the tone, describing the central bank and its monetary watchdogs as “crazy.” With his latest statements the US President is again stepping up to the next stage of escalation. Not only has Trump said that he now regrets appointing Powell as Fed Chairman, but in response to a journalist’s question as to under what conditions he would fire the central bank Chairman, Trump also replied that he didn’t know. A few weeks earlier he had replied to the same question with the clear answer that he would not dismiss him. What’s more, Trump is now openly calling for lower key rates.

 

The power of the US President: He determines the Fed Chairman

The most important question that financial market players are asking is what powers the US President has to remove the Fed Chairman from office. This question is taking on ever greater priority as Trump has already spun the personnel merry-go-round vigorously since his inauguration and has changed his staff often. In fact it is written in the Federal Reserve Act Sec. 10 that “…each member shall hold office for a term of fourteen years from the expiration of the term of his predecessor, unless sooner removed for cause by the President.” Theoretically this passage grants the US President the power to remove a member of the Fed’s governing council – and this includes the Chairman. Ultimately, however, there is no precise explanation of what grounds would have to be cited for this. A monetary policy that does not suit the US President is certainly not a reason to remove the Fed Chairman from office.

 

Criticism of the US central bank could backfire

Trump’s statements are counterproductive for several reasons: for example, in order to prove its independence the US central bank could raise key rates more than most market players expect and/or more than the monetary watchdogs currently intend. Taken to the extreme this could possibly lead to a recession or at least to an economic slowdown. The US President would then achieve precisely the opposite of what he hoped to achieve with his statements. There is also the danger of a self-fulfilling prophecy. If consumers take seriously the US president’s fears that the US central bank will put an end to the upswing with further key rate hikes, then because of the uncertainty this causes aggregate demand could decline. As a result, the growth dynamic would also lose a lot of its momentum. Last, but not least, if the Fed were to bow to the President’s criticism, financial market players could be concerned that the Fed chief had become the US President’s stooge and no longer has an eye on economic factors, such as inflation, for example. There is a danger here that inflation expectations would lose their anchor, which in turn would harbour the risk of a return to high inflation rates, leading to rising capital market yields. Ultimately, in such an environment the Fed could be obliged to slam on the monetary-policy brakes – with the risk of conjuring up an adjustment recession.

 

The squaring of the circle

In our view, the Fed will not bow to the US President’s attempt to exert influence on it. The Federal Reserve is legally independent and thus protected from the US President’s directives. At the end of the day Trump is calling for the squaring of the circle: Economic growth should be extremely dynamic, the unemployment rate and inflation low, while at the same time the dollar should not appreciate and capital market yields, including against the background of the high level of issuing activity by the state, should remain low. Especially ahead of the midterm elections it may be assumed that the US President will continue to level severe criticism at the Fed. But the monetary watchdogs have already implicitly announced a further key rate hike in December and this is expected by market players with a probability of almost 75%. So the Fed is hardly likely to change its mind. In the medium to longer-term, the Fed is also likely to gear its monetary policy stance especially to the economic situation. The robust job creation and an inflation rate near the Fed’s two per cent target justify further key rate increases at least at the moment. Not least, it needs to be borne in mind that so far the US central bank has not held out the prospect of running a significantly restrictive monetary policy. Key rate hikes slightly above the neutral level are not likely to do any lasting damage to the outlook for the economy.

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