By Mike Dolan
LONDON, March 22 (Reuters) – It may seem strange for a central bank chief to clinch a rare soft landing for the US economy and then face the sack — but that very real possibility has many investors worried about potential post-election risks to the Federal Reserve’s independence.
Several banks recently delved into claims by former president and Republican presidential candidate Donald Trump – neck and neck in opinion polls with incumbent Joe Biden – that if he is elected in November he will not reappoint Jerome Powell when the Fed chair’s term expires in 2026 ..
And while many downplay the White House’s ability to politicize the Fed’s monetary policy per se – they acknowledge investors’ concern about the pressure and suggest that even a change in style and tone with a new Fed chief could be on the cards.
Trump himself nominated Powell in 2017, but then quickly turned on him in a series of public pamphlets as the Fed continued to raise interest rates through 2018 despite his pleas to the contrary – branding him “clueless” at one point.
And last month the former president insisted on this again he did not appoint again the 71-year-old Powell, complaining that any tax cuts in the coming months would only be designed to boost the Democrats in an election year.
The Wall Street Journal reported last weekend that Trump’s team had already discussed three potential replacements — former Fed Governor Kevin Warsh, former Chairman of the Council of Economic Advisers Kevin Hassett and former Ronald Reagan guru Arthur Laffer, known for his a controversial consideration of the relationship between taxes and government revenue.
While everything remains in the realm of speculation — and another finely balanced White House race is still eight months away — it’s a delicate moment for the Fed and central banks in general because of the bruising two-year battle they’ve just waged against the Fed. post-pandemic inflation spike worldwide.
Although inflation is easing to 2% targets in most major economies, investors are now very sensitive to where it settles in the long term as a recession, at least in the US, appears to have been avoided in the disinflation process.
Without specifically mentioning the United States or the Fed, the head of the International Monetary Fund Kristalina Georgieva said on Thursday that numerous elections around the world this year were a good moment to emphasize the importance and the success of the independence of the central bank historically.
“Risks of political interference in bank decisions and personnel are rising,” she wrote in a blog on the IMF’s website. “Governments and central bankers must resist these pressures.”
Although the IMF has its work cut out for many developing economies in which independence is often unclear, the combination of high inflation and high debts is hardly the preserve of emerging markets alone – nor do they seem to struggle to keep inflation management away from government direction. .
Georgieva said governments’ adherence to their own sound budgeting and debt control is also critical to allowing central banks to operate without influence.
“Implementing prudent fiscal policies that keep debt sustainable helps reduce the risk of ‘fiscal governance’ – pressure on the central bank to provide low-cost funding to the government, which ultimately fuels inflation.”
COUCHUCHUCHUCHUCHUSTIMONES
How much of the Fed’s post-election risk debate is already swaying investors is harder to analyse.
Morgan Stanley’s chief global economist Seth Carpenter, who spent 15 years working at the Fed, cited multiple client questions about the Fed’s independence ahead of the election — but said there was no evidence or experience to doubt the Fed’s insistence , that it is far from the Fed. election cycle
“What happens after the election is a different story,” he added.
New appointments to the Fed chair or board can influence communication or disagreement on policy, Carpenter wrote, even though the institution was well insulated.
The next presidential term only had two Fed vacancies, he added, far from a majority.
One safeguard in the extreme event of the White House trying to install a “rubber stamp” Fed chief was the fact that the Federal Open Market Committee chooses its own chair according to the letter of the law – even if by convention it differs from the chairman of the Fed board elected by the President and Senate.
“A new Fed chair could very well change the reaction function of the FOMC at the margin,” he added. “But the institutional process is designed to guard against the extreme case of a Fed that is directed by the White House instead of the dual mandate.”
How would markets react anyway if they were rattled by either direct public pressure to keep rates low — or indeed fresh fiscal expansion that forced the Fed to hang on because of concerns about the Treasury market or broader financial stability?
Long-term market inflation expectations, for example, may begin to climb again. Already, 10-year measures of these USBEI10Y=RR, USIL5YF5Y=R remain 30-50 basis points above 2% Fed targets – but they have remained around those levels for the past year and other risk premiums in bond markets remain under wraps.
Barclays currency strategists point out that the first Trump presidency was associated with repeated calls for lower interest rates along with a tax-cutting fiscal expansion — but the Fed resisted and raised rates anyway, much to the chagrin of the then-President.
However, the more inflationary post-pandemic world raises the bar on any political inaction going forward, they reckon.
“A scenario in which the Fed follows a fiscal expansion path is more obviously inflationary than in 2016,” they concluded. “When this leads to a steeper U.S. curve, it would probably also result in dollar weakness, all else being equal.”
All hypothetical at this early stage of course – but markets may not last as opinion polls ebb and flow into November.
The opinions expressed here are those of the author, a Reuters columnist
Fed Rates and US Presidential Elections
The Fed is holding rates steady while the decline in inflation stops
IMF chart on central bank independence around the world and in Latin America
The point-plot of the Fed
Biden, Trump closely matched in White House race
(Editing by David Evans)
((mike.dolan@thomsonreuters.com; +44 207 542 8488; Reuters Messaging: mike.dolan.reuters.com@thomsonreuters.net @))
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