There’s no escaping the fact that that Donald Trump hasn’t been holding back in his criticism of the Federal Reserve’s stance over monetary policy. With four interest rate hikes in 2018 and a further two currently expected in the year ahead, the return to ‘normal’ borrowing costs after a decade of cheap money is having a profound effect on many corners of the market. Consumer demand is slowing, businesses are less willing to borrow to fund expansion and equities start to look a little less attractive when compared to the risk free returns of government debt. On top of all this, the prospect of meaningful yields on dollar deposits is pushing up the value of the greenback, making life significantly more challenging for US exporters.
That set of affairs doesn’t sit well with Donald Trump, despite Powell having navigated the economy to an enviable position where inflation is close to target and practically every American who wants to work has a job. What’s more, Powell was Trump’s nomination for the job after Janet Yellen’s term expired in February 2018, but with the President threatening to fire the Fed chief, what does that mean for markets?
Historically, central banks weren’t independent of government, but rampant inflation in the 1960’s and 1970’s saw many campaign to set the agenda free of political influence. This was arguably ideal as it enabled a longer-term view to be taken, going well beyond the next round of elections, and provide a more prudent approach to be taken.
If we do see Donald Trump move to replace Jerome Powell, presumably it would be with someone who would advocate lower interest rates, so any suggestion this will happen has the potential to result in three key market movements.
But this is far from a risk-free gambit. Recent political intervention in central banks hasn’t been well received at all. The governor of the Reserve Bank of India quit his post after politicians intervened regarding the use of regulatory capital, whilst the Turkish President’s move to put his son-in-law in charge of economic policy has proved ‘challenging’ for the Lira.
A move to defy traditional schools of economic thought and push interest rates lower whilst the economy is expanding could have two key consequences.
What we have learnt over the last two years is that Donald Trump is more than willing to push boundaries for short term gain. The tax breaks allowing US companies to repatriate cash held overseas drove a sharp rally for both the stock market and the economy as a whole, but this stimulus is already proving short lived. With a President who a times appears willing to see himself judged on little more than the performance of Wall Street, it’s perfectly believable that he could look to have Jerome Powell replaced with someone more willing to reflect his own views. That would come at a price – dollar depreciation and rampant inflation – but it would have the potential to generate some attractive trading opportunities, too.
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In January the Fed needed to put the Taper Genie back in the bottle; now they need to convince the short end crew to back off repricing the Fed Funds strip