Trump vs The Fed - What's next?

President Donald Trump’s longstanding criticism of Federal Reserve (Fed) Chairman Jerome Powell—ironically, someone Trump himself appointed during his first administration— came to a head when the White House confirmed two weeks ago that it was studying legal options to fire Powell.

While Trump’s dissatisfaction with the Fed and Powell is no secret, the announcement triggered concerns that concrete efforts were made by his administration to replace Powell and, most significantly, potentially chip away at the Fed’s independence. The resulting market reaction was so swift and negative that Trump quickly reversed course. Yet, there remains a lingering market concern that the question of Fed independence will be raised again in due course, particularly if it delays cutting policy rates.

While the likelihood of a direct challenge to the Fed’s independence has subsided for now, this recent episode has highlighted the potential for political jawboning over monetary policy and the lasting assumption about Fed independence. This alone can disrupt market expectations, further destabilize inflation forecasts, and undermine the credibility that anchors the U.S. dollar and Treasury market. Understanding how all of this could unfold—and how markets might react—is essential in an environment already shaped by elevated policy uncertainty.

What happened?

After a series of public comments and social media posts from President Trump criticizing the Fed and its tardiness in cutting rates, National Economic Council Director Kevin Hassett said that the President was studying whether he’s able to oust Fed Chair Powell. White House lawyers were privately reviewing various legal options, including whether Trump could fire Powell for “cause.”

The market reaction was severely negative—Treasury yields moved sharply higher, the U.S. dollar weakened, and equities fell. With both risk and traditional safe haven assets shunned, it potentially hinted at the diminishing appeal of U.S. dollar-denominated assets as investors began to fear a deep unwinding of U.S. policy credibility.

That was seemingly enough to convince Trump to back down, later stating that he has “no intention” of firing Powell.

Why is Fed independence important?

The operational autonomy of the Fed, 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 with respect to its mandates. Indeed, economic studies suggest that central bank independence lowers the inflation rate in developing economies by between 1 and 6 percentage points¹ . In addition, estimates indicate that a loss of Fed independence would cumulatively increase CPI by 11 percentage points by the end of 2028.²

It is also worth remembering that monetary policy, in the long run, only drives inflation and not growth. In other words, while a looser monetary policy bias would likely raise GDP in the short-term, it would do so at the expense of longer-term growth, and vice versa. Once the market realizes the loss of independence, it is likely to increase the risk premiums associated with financial and real investments in the U.S. economy. This could lead to capital outflows, a decline in physical investment, and a significant depreciation of the dollar.

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: he is both the Federal Board of Governors Chair and FOMC Chair, as well as a member of the Board of Governors. His term as 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.

Clashes between the President and the Fed are not unusual, especially at times when fiscal and monetary policy move in opposite directions. It’s hard, if not impossible, to recall a President who did not clash at some point with the Federal Reserve.

In an extreme example, President Lyndon Johnson in 1965, having delivered a powerful fiscal stimulus package a year earlier amid the Vietnam War, summoned then Fed Chair William Martin to his Texas ranch and physically shoved him around his living room to bully him into keeping interest rates low.³

Legally, the President’s ability to remove Powell faces some uncertainty. The Federal Reserve Act of 1913 does allow the President to remove the Board Chair—Jerome Powell—“for cause.” This is a term that courts have historically interpreted as requiring “inefficiency, neglect of duty, or malfeasance in office.” In this instance, policy differences aren’t enough justification according to historical legal precedent.

Notably, the Act doesn’t say anything about Trump removing a Fed Chair as it is selected by members of the FOMC, not the President.

Ultimately, it is the Supreme Court who may decide whether President Trump can fire Mr. Powell, depending on whether the court overturns the legal precedent assumed to provide protections to the Federal Reserve (Humphrey’s Executor) and other independent agencies within the purview of the executive branch. In this scenario, the administration could be granted the broad authority to reshape the Federal Reserve System by removing Powell and other Governors. At the most extreme, Trump could fill all the FOMC roles with administration loyalists, thereby ensuring that they all follow the President's directives.

What’s stopping the President?

The market serves as an important check to 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. This would be manifested 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 looks to unveil a new tax cut bill that may require a further expansion of the deficit.

This knowledge should provide investors with some comfort as they try to map out the reaction function of Trump with future policy choices.

Implications for investors

With Trump backing down from his threats to fire Powell, investors can breathe easier… at least for now. Indeed, the Fed’s wait-and-see approach to policy opens itself to potentially renewed criticism from the administration, particularly considering the latest GDP data release which showed that the U.S. contracted in Q1.

As a result, investors should be prepared to see more volatility emerge. Longer-end interest rates are susceptible to upward pressure, particularly if inflation expectations rise, potentially hurting long duration assets. Against this backdrop, positioning in short duration fixed income assets would be preferable.

Concern about Fed independence further strains the relative attractiveness of the dollar. Investors with global mandates could benefit from increasing allocations to alternative safe haven currencies like the Japanese Yen or Swiss Franc. Moreover, increasing exposure to gold or other precious metals is likely to be favorable, though given very frothy pricing, investors should proceed tactically.

Finally, and most importantly, for longer-term investors, the increasing challenges to the U.S. and the credibility of its institutions adds to investor proclivity to reassess U.S. exceptionalism, a theme that is seemingly becoming more structural rather than tactical with each passing headline. Capital markets are shifting and an increased focus on global diversification means that a sophisticated and active appraisal of international opportunities has become a requirement for all investors.