Rate Cuts at the Expense of Fed Independence?

This was a “rip up the script” morning.  I was working on a piece about the uninspiring reactions to the first two days of bank earnings and how the market seemed to be consolidating its recent gains when a bombshell headline dropped: “Trump Likely to Fire Powell Soon, White House Official Says”.  That’s a potential game changer.

It has been quite evident that President Trump wants to see Powell removed from his position as Federal Reserve Chair.  Markets reacted poorly after the President first expressed his desire to fire Powell a few weeks ago, so it appeared that he then seemed inclined to wait until the Chair’s term expires in May 2026.  The global reaction to the potential diminution of central bank independence was enough to chasten Trump, at least for a while.  But the President has been applying pressure on Powell ever since.  Barely a day goes by without a call for lower rates, sometimes accompanied by an insult.  Furthermore, the investigations into the costs of the Fed’s recent renovation, led by Federal Housing Finance Agency head Bill Pulte, can certainly be interpreted as searching for a reason to fire the Chair for cause. 

The immediate reaction from the bond and currency markets was what we should have expected.  Short-term interest rates plunged on the notion that a new Fed Chair would be far more inclined to cut rates quickly than Powell.  We saw 2-year yields drop by about 8 basis points, but long-term rates rose on fears that aggressive rate cuts might increase inflation.  It is quite fair to expect a steeper yield curve under a less-wary Fed.

Meanwhile, the dollar fell by about 1% against a basket of major currencies.  It is difficult to untangle the factors that affected the dollar, however.  The most basic reason would be the drop in short-term rates.  All things being equal, lower short-term rates in a particular country depress its currency versus a counterpart where rates haven’t moved.  But there is more to consider when it comes to the dollar recently.  We’ve asserted that the general dollar malaise reflects a slow leak out of US assets, notably on days when the dollar falls even as US rates inch higher.  Moves that threaten the Fed’s independence could certainly exacerbate that trend.

Stocks, however, did little, and the reaction seemed delayed as well as muted.  There are a few possible reasons.  They include:

• Stock investors are so enamored with the idea of lower rates that they don’t care if they come as the result of governmental interference. 
• The weaker dollar is a boon to the multinationals that dominate major US stock indices
• Traders are so loath to miss a dip buying opportunity that they don’t bother selling, even if the news seems dire

Yet once again, the dip buyers – or in this case, the “non-sellers” were vindicated just a few minutes later.  During a press briefing, Trump responded to a question about Powell’s potentially imminent firing by saying, “No, we’re not planning on doing anything.”  He certainly didn’t hide his disdain for the current Fed Chair, but his comments led to a reversal of the late-morning trends.  The reversals weren’t complete, though.  As I write this shortly after noon EDT, we see bonds and the dollar recouping about half their drops, though stock indices reverted to roughly unchanged levels.

We have to wonder if the earlier report was a trial balloon designed to see how markets might react to if Powell were indeed fired.  Quite frankly, the relatively muted reactions from stocks and the 10-year bond might have increased the President’s willingness to take action, since the initial reaction was hardly catastrophic.  Stay tuned – this drama is nowhere close to its end.

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Originally Posted on July 16, 2025