Stocks rallied on news that President Trump would not be firing Federal Reserve Chairman Jerome Powell, news that came right after reports that he was seriously considering it. In typical market fashion, a negative was turned into a positive simply by walking it back, which is to say we ended up right where we started, only with higher prices.
It seems Trump was running a kind of trial balloon (or maybe a weather balloon) to test sentiment by floating the idea of Powell’s sacking. The reaction was swift and clear. Stocks slumped and long-term bond yields jumped. Soon after, the president reassured everyone that firing Powell was “highly unlikely.”
So, why the tension? President Trump wants the Fed to cut rates, immediately and aggressively to boost the US economy and “Make America Great Again.” Powell, on the other hand, is more focused on the Fed’s dual mandate on full employment and price stability. Judging by this week’s inflation data, he has a point.
Remember that interest-rate policy is meant to be forward-looking. Inflation, on the other hand, is kind of like a side mirror on the highway. Trump argues that inflation is low now, so the Fed should act now but he seems to be ignoring the expected inflationary effects of his own aggressive trade policies. Unsurprisingly, economists predict price pressures to increase in the coming months.
Meanwhile, long-term interest rates which the Fed does not control have started to climb. The 10-year yield is back to 4.5% and the 30-year is comfortably above 5%.
Trying to kick Powell out before his term ends would be a blow to the Fed’s independence and credibility. That kind of action would likely spike long-term inflation expectations, send risk assets into another tailspin, and weaken the dollar.