A Game of Chicken: The Politicization of the Federal Reserve

I have been in the financial industry for 35 years and I can honestly say I have never seen the Federal Reserve so politicized.

As a reminder, the Federal Reserve was established by Congress in 1913 as the independent central bank of the United States. According to Investopedia, its purpose was to “provide the nation with a safe, flexible, and stable monetary and financial system.” It is made up of a board of governors located in Washington D.C. and 12 regional Federal Reserve Banks across the country. The board chairman is the chief decision maker and spokesman for the Federal Reserve. The current chairman today is Jerome Powell.

There seems to be a game of chicken going on between Chairman Powell and President Donald Trump. The president has made it widely known to the world that he thinks America’s short-term interest rates should be considerably lower than they are today to keep the economy strong and the stock market high.

Fed Chairman Powell has had to deflect President Trump’s personal criticism of him for not lowering interest rates quickly enough. A quarter point move down in the Fed Funds Rate two weeks ago was clearly not enough to appease the president. Instead, Powell has claimed the Fed governors are carefully monitoring the three mandates in the economy that they are responsible for, “full employment, stable prices and moderate long-term interest rates.”

At the last post-Fed meeting press conference, Chairman Powell equivocated about the direction of interest rates going forward. He said the Fed might lower rates again at its September meeting, but he also said the Fed could pause and decide to actually raise interest rates later in the year. The markets were expecting him to say the Fed would continue cutting interest rates if necessary. Both President Trump and investors reacted negatively to his ambiguous comments.

Recent tariffs on Chinese exports to the U.S. have caused havoc with interest rates, the Chinese Yuan and global stock markets. If this trade war continues to escalate further and a recession ensues, then Chairman Powell will have no choice but to continue cutting interest rates even further, which is exactly what President Trump wants.

Chairman Powell is damned if he does and damned if he doesn’t.

The reason the Federal Reserve is so effective and powerful is because of its political independence. The markets react to what the chair of the Federal Reserve says and in past crises, the Fed’s actions have provided a calming influence when markets panicked. We saw this with the 1987 stock market crash, and most recently, during the financial crisis in 2008-2009. The Federal Reserve can quickly and suddenly cut interest rates to stimulate the economy and the markets typically react quite favorably to those movements.

Today, Powell can’t appear to be giving in to President Trump. At the same time, he needs to react to changing economic conditions in the U.S. and around the world. There is a fine line between doing what the president wants and what is best for the economy. The Federal Reserve needs to maintain its political independence or risk losing all credibility with the markets.

Not sure how this game of chicken will play out, but it certainly is keeping investors on their toes. Fasten your seat belts.