Pray for the US Treasury market
On the assumption that a chaotic, incoherent trade war was baked in the cake, FT Alphaville’s main bet for a financial-economic calamity under Trump 2.0 has long been that he launches a full assault on the Fed.
Well, it’s here now:
Donald Trump said he was firing Federal Reserve governor Lisa Cook “effective immediately”, in a stunning escalation of the US president’s attacks on the central bank.
In a letter to Cook posted on social media on Monday night, Trump said there was “sufficient reason” to believe she had made false statements on mortgage agreements, giving him cause to fire her.
Cook has said she will contest the firing and continue to carry out her duties in the meantime. The fact that the dollar and US Treasuries didn’t weaken dramatically indicates that investors are nervy about this latest development, but not freaking out quite yet, possibly on the assumption that the firing won’t stick. After all, Cook hasn’t even formally been charged with anything yet.
As Ebrahim Rahbari at Absolute Strategy Research noted:
The President has the power to fire Fed Governors for cause under the Federal Reserve Act, but leaves cause undefined. Any court case would therefore hinge on whether the evidence meets the judicial bar for ‘cause’ rather than questions about presidential powers. This is therefore different from the Supreme Court ruling in May that noted that the President can fire leaders in government agencies without cause, but exempted the Fed from the ruling. It is possible, but not certain, that this case could also end up at the Supreme Court to clarify the bar for ‘cause’. Even though it is likely that the courts would expedite this case, it could take some time: an initial district court ruling may be quick/within a few weeks. The emergency Supreme Court ruling in May came 3.5-4 months after the initial firings.
However, the initial market reaction looks preposterously sanguine, given that this move cannot be seen in isolation. It was just weeks ago that president Trump sacked the head of the Bureau of Labor Statistics after an unflattering jobs report. Entrenched expectations of norms and institutional integrity are now kaput.
Many investors have drawn comfort from the argument that any forceful attempts to take over and reshape the Federal Reserve would trigger a bond market hissy fit that even the Trump administration has shown a fear of. However, the nakedly political move against Cook shows that it is not nearly as worried about the market fallout as investors have assumed.
Even if Cook were to eventually prevail through the courts, her hounding shows to everyone else on the Fed board that the Trump administration is gleefully willing to unleash its full clownshow on anyone that displeases them. That could easily have a pernicious impact on the central bank’s policymakers. They wouldn’t be human if they didn’t worry about a weaponised US government using all its available tools to harass them.
And if Cook is forced out of the Fed, it isn’t just another seat available to the White House’s tragicomically long and undistinguished list of candidates. With Stephen Miran likely to be confirmed to the seat vacated by Adriana Kugler soon, and Miki Bowman and Chris Waller already in place, Trump appointees would enjoy a majority on the seven-person Federal Reserve Board.
That may not be enough to immediately seize control of the fed funds rate, thanks to the votes enjoyed by the regional Federal Reserve presidents, but it would give them control over the Fed’s budget, staffing and — crucially — approval of the regional Fed presidents.
Those regional Fed heads are appointed by theoretically independent local boards of potentates, but they require approval from the Fed board in Washington, and the five-year terms of all are due to expire in February.
You’d hope that Chris Waller — one of the more credible Trump 1.0 appointees — might not roll over, but he is clearly very keen on securing the chairmanship when Jay Powell gets jettisoned next year. And to do so he might need to demonstrate his loyalty, perhaps by shivving his regional Fed colleagues early next year, ahead of Powell’s inevitable ousting in May.
As Rahbari said:
Overall, I expect a deeper and broader takeover of the Fed by the Trump administration, and therefore probably somewhat wider implications beyond the general idea that we’d see some pressure to lower interest rates, constrained by the existing institutional guardrails.
I stress: i) a majority of Board governors can significantly influence the (re)appointment of regional Fed presidents, ii) I expect significant Fed staff turnover (including terminations), particularly once a new Chair takes over, iii) significant impact for the Fed’s regulatory functions, iv) an impact on the Fed’s balance sheet policies and v) to remember that the administration’s focus on the Fed is partly defensive, as it had long worried that its policy agenda could be stifled by ‘bond vigilantes’, with the Fed a potentially powerful defense mechanism.
Economic and financial realities will constrain Fed decisions even under new leadership, but dependencies with the White House are likely to ramp up sharply.
If a Trump Fed lowers interest rates aggressively then short-term Treasury yields would probably fall, but longer term yields would rocket higher on fears that inflation will stage a strong comeback.
The 30-year Treasury bond yield — where most of the pain would probably fall if Trump succeeds in taking over the Fed — has climbed to 4.94 per cent this morning. That’s up from 4.75 per cent earlier this month, but still below the 5 per cent mark we last breached in May and October 2023.
The relatively muted market reaction is probably partly due to timing: Trump moved against Cook late in the US evening, and big Asian investors aren’t known for moving with alacrity. We’ll probably see a bit more of a reaction as European trading really cranks up, and especially when American traders return to their desks.
The Treasury market has been remarkably tranquil recently, but if even this doesn’t shake things up then you can expect the Trump administration to be emboldened. As Rabobank said:
The unabashed politicization of the supposedly independent and technocratic process of setting the price of money once again confirms that it is no longer the 1990s and that old ideas about optimal policy transmission, central bank credibility and the need to insulate important decisions from the influence of the popular will offers little protection against the new paradigm of raw power politics.
Just as the interpretation of law is inherently political, the price of money is inherently political, and all aspects of national policy are being co-opted to support the MAGA vision of the United States and its place in the world.