Trump's criticism of Powell creates renewed threats to the Fed’s independence

President Donald Trump’s longstanding criticism of Federal Reserve (Fed) Chairman Jerome Powell—ironically, someone Trump appointed during his first administration—remains front and center. The most recent flashpoint came about last week when Trump drafted a letter firing Chair Powell and asked GOP lawmakers whether he should send it. The resulting market reaction was so swift and negative, as long-end bond yields surged and the dollar fell, that Trump quickly reversed course and indicated he wasn’t planning to fire Powell.

While Trump’s dissatisfaction with the Fed and Powell is no secret, Trump’s recent remarks have exacerbated market concerns that the question of Fed independence will be raised again in due course, particularly if the Fed delays cutting policy rates.

Understanding how this could unfold—and how markets might react—is essential in an environment already shaped by elevated policy uncertainty.

Why is Fed independence important?

The Fed's operational autonomy, especially when it comes to setting interest rates, is paramount to bond market investors. Its independence ensures market credibility, provides a foundation for inflation expectations, and, as a result, gives confidence to buyers of U.S. Treasury securities—both domestic and foreign. This confidence helps dampen interest rate volatility, particularly at the long end of the yield curve. Any erosion of this trust could lead Treasury buyers to seek alternatives, leading to higher U.S. interest rates.

Furthermore, its credibility increases the effectiveness of its conventional policy toolkit and allows it to implement unconventional policies, including forward guidance and asset purchases.

Crucially, monetary policy actions are most beneficial when central banks are divorced from the short-term political cycle, instead focusing on the longer-run perspective concerning its mandates. Indeed, economic studies suggest that central bank independence lowers the inflation rate in developing economies by between 1 and 6 percentage points ¹ . In addition, estimates indicate that a loss of Fed independence would cumulatively increase CPI by 11 percentage points by the end of 2028 ² .

As such, it is clear that the economic fallout from a loss of central bank independence—and compromised monetary policy—would likely be severe.

What is President Trump’s authority to fire Jerome Powell?

Jerome Powell holds three positions at the Fed: the Federal Board of Governors Chair and FOMC Chair, as well as a member of the Board of Governors. His term as Board Chair and FOMC Chair expires in May 2026, and his term as a member of the Board of Governors ends in January 2028. Distinct from the Board Chair, which is nominated by the President and confirmed by the Senate, the Federal Open Market Committee (FOMC) Chair is chosen by members of the FOMC—not the President—although historically the same person fills both roles. It’s also rare for members of the Board to stay on after their term as Board or FOMC Chair ends.

The president’s ability to remove Powell remains legally ambiguous. The Supreme Court has recently created a carve-out for the Fed that protects Powell from being fired without cause. However, the Federal Reserve Act of 1913 allows the President to remove members of the Federal Reserve Board, including Jerome Powell, but specifically only “for cause.” Courts have historically interpreted this term as requiring “inefficiency, neglect of duty, or malfeasance in office.”

Most recently, the administration has taken steps to criticize Powell over his handling of the Fed’s extensive renovation project in its buildings in Washington as a potential pretext to fire Powell “for cause.” However, it is worth noting that this approach still faces significant legal uncertainties.

Separately, the Act doesn’t say anything about Trump demoting a Board Chair— presumably in the hope that Powell would then also step down as Fed Chair—though this would also likely lead to a potentially protracted court battle, especially as there is no historical precedent for such a move. Moreover, even if the administration was successful, it still allows Powell to serve the rest of his term as a member of the Board of Governors until 2028, continuing to exert his influence on the FOMC.

What’s stopping the President from following through on his threats?

The market serves as an essential check to any president's, including President Trump’s, actions with the Fed, and will likely make its voice known clearly and aggressively if it senses a loss of the Fed’s independence. As witnessed last week, this would result in increased market volatility, a weaker dollar, and higher long-end yields. This threat of bond market turmoil is likely what prodded Mr. Trump to soften his stance on firing Powell, and what could keep the administration from pushing the envelope further.

This is particularly true amid the administration’s focus on keeping interest rates low, as it needs to roll over about 30% of maturing debt this year and as Congress passed a new tax cut bill that requires a further expansion of the deficit.

How will Fed policy be impacted?

Given the potential market fallout, it seems unlikely that President Trump will fire Chair Powell. However, with Powell’s term as Fed Chair ending in May, Trump could accelerate his pick for the next Fed Chair, choosing to nominate one as early as the fall as he has said. If openly very vocal, this nominee could potentially override the Fed’s ability to provide forward guidance. While investors have largely dismissed these concerns, the fact that current Treasury Secretary Scott Bessent was the first to introduce the idea of creating a “Shadow Fed Chair” gives it a bit more weight. Moreover, even if the next Fed Chair is credible and independent, markets may also be increasingly suspicious of future Fed decisions.

Of course, the Fed will likely try to ignore all the political undertones and instead focus on a data-dependent approach. Unfortunately for them, the current data does not tell a clear economic story—major structural forces underway in the labor market may further exacerbate conflicting signals, and tariff policy remains highly uncertain. With the economy failing to provide a definitive rationale for policy decisions, it leaves greater scope for question marks over the Fed’s decisions and motivations.

Decisions to continue holding rates steady will amplify political noise, and there are risks that markets may perceive such a policy move as motivation to emphasize Fed independence. On the other hand, any future rate cuts may be tainted with some suspicion around politicisation.

How does all this impact financial markets?

The latest development introduces another unwelcome source of uncertainty for investors, adding volatility to a year already marked by significant policy upheaval.

This challenged policy backdrop is likely to drive bond market volatility and potentially reduce the effectiveness of the Fed’s monetary transmission mechanism. Indeed, if central bank credibility continues to be eroded, whenever the Fed resumes its rate-cutting cycle, the resulting drop in longer-end bond yields may be muted by an increase in risk premiums—flying directly in the face of what President Trump is trying to achieve.

Finally, these dynamics should add to the ongoing near-term headwinds facing the U.S. dollar. A return to policy certainty and credibility is likely needed to put a floor under the greenback. Absent that, the continued stress around the independence of U.S. institutions should keep the dollar vulnerable to further downward adjustment.

Principal Asset Management