Market Brief: Markets Plunge as Trump Administration Steps Up Threats Against Fed

Financial markets are getting hit again this morning, with US equity indices, Treasuries, and the dollar all tumbling in synchrony as investors assess new threats to the Federal Reserve’s independence against an increasingly-forbidding growth backdrop in the world’s largest economy.

The greenback dropped more than 1 percent on a trade-weighted basis in overnight markets after the Trump administration stepped up its attacks on Jerome Powell, threatening to demolish the Fed’s hard-won independence from political pressure. In a series of posts on his Truth Social platform last week, Trump argued that interest rates should be cut, saying “Powell’s termination cannot come fast enough!”. On Friday, Kevin Hassett, director of the National Economic Council, said the president was studying whether he has the legal capacity* to fire Powell, claiming that the chair – who is a registered Republican – has acted to favour Democrats since being appointed by Trump in his first term.

The administration’s threats come as Fed officials worry that a simultaneous worsening in inflation and growth expectations could prevent the smooth adjustment of policy to changing economic circumstances. In an important speech last week, Powell said “While uncertainty remains elevated, it is now becoming clear that the tariff increases will be significantly larger than expected. The same is likely to be true of the economic effects, which will include higher inflation and slower growth. The size and duration of these effects remain uncertain. While tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could be more persistent. Avoiding that outcome would depend on keeping longer-term inflation expectations well anchored, on the size of the effects, and on how long it takes for them to pass through fully to prices. Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem”. “For the time being,” he said, “we are well-positioned to wait for greater clarity before considering any adjustments to our policy stance”.

Firing an active Fed chair could unleash consequences that make recent market turmoil look tame. If the central bank’s dual mandate – preserving price stability and fostering full employment – is diluted with a new set of objectives defined by the White House, policymakers could find themselves unable to tighten policy dramatically in the face of a sudden increase in prices, meaning that rates are persistently kept below “neutral” levels, and that inflation remains higher over the long run. This would raise fears of a return to the 1970’s – when Richard Nixon’s pressure on Fed chair Arthur Burns helped trigger a series of cataclysmic price cycles – and might generate a steep rise in long-term interest rates, a collapse in investor risk appetite, and a plunge in the dollar.

We suspect cooler heads will prevail. Administration officials – most notably Treasury Secretary Scott Bessent – are unlikely to support an all-out attack on one of the foundational institutions of the global financial order, and should be able to convincingly argue that the president’s economic objectives would not be well met by renewed turmoil in global markets.

But it is getting difficult to argue that the US “exorbitant privilege” hasn’t been damaged. The flow of foreign cash into American financial markets that helped lift relative asset valuations to multi-decade highs is showing clear signs of reversing as policy uncertainty soars, growth forecasts collapse, and inflation expectations climb. Private investors and official institutions are reallocating funds outside the United States, helping to boost the fortunes of virtually every major currency against the greenback: the euro, pound, Swiss franc, Japanese yen, Canadian dollar, and Mexican peso have all moved beyond key technical levels in recent days, and are showing signs of extending gains beyond today’s North American open.

Our contrarian alarm bells are going off nonetheless, and we think a technical rebound in the greenback could be in the offing. With speculative pressure against the dollar intensifying and sentiment nearing multi-year lows, positioning looks vulnerable to a squeeze. Although long-term views on the dollar are moving lower for good reasons, positive news on the trade or financial front could easily trigger a fairly violent recovery in the coming days.

Next Monday’s Canadian general election is not ruffling feathers in the foreign exchange markets. Poll aggregators and forecasting models are pointing to a conclusive victory for Mark Carney’s Liberal Party — marking an astonishing recovery from the situation on January 6, when former prime minister Justin Trudeau rendered his resignation — but both candidates have adopted strongly defensive postures on US-Canada trade relations, and both are promising an expansion in fiscal stimulus to offset underlying economic weakness**.

Policymakers at the Bank of Canada are as uncertain as the rest of us. In last week’s decision, officials set out two “illustrative scenarios” for the Canadian economy – one in which tariffs are ultimately reduced but high uncertainty levels exert drag on the economy, and a second, in which a global trade war cripples exports, clobbers business investment, and hits consumer spending, forcing the government to step in with a big stimulus boost.

Canada likely has the room for a modest fiscal expansion, given that it entered the 2020 coronavirus pandemic with lower government debt than its Group of Seven peers, and that it has not followed the US in delivering an outsized boost to growth in the ensuing years. We don’t expect funding markets to rebel against the victorious candidate, and think the Canadian dollar will keep dancing to a tune played elsewhere.

*In theory, the president’s power over the central bank is quite limited under current law. He can nominate officials who are sympathetic to his views, but the replacement process takes years, confirmation is subject to the same Senate committee approval procedure that blocked Sarah Bloom Raskin during the first Trump administration, and the regional Fed presidents would remain outside his purview. He could choose to fire Jerome Powell before his term ends in 2026 – the Federal Reserve Act of 1913 allows the president to dismiss a sitting chair “for cause” – but this would undoubtedly face serious legal challenges. However, recent moves to overturn the 1935 ‘Humphrey's Executor’ legal precedent – which limited executive power over independent agency heads – could mean that a “fire now, gain permission later” strategy ultimately succeeds.

**As it stands, the Liberals have presented a costed budget plan which sets out a raft of additional "investment" (spending) initiatives funded through increased borrowing, while the Conservatives are promising tax cuts that would also amount to an increase in borrowing.

Economic Calendar