Beyond the Sturm and Drang Over Fed Independence, Little Actually Changed

Editors’ Note: MarketMinder is politically agnostic. We prefer no politician nor any party and assess developments for their potential economic and market implications only.

Evidently, the gloves are off. On Friday, the US Justice Department issued a grand jury subpoena to Fed head Jerome Powell, threatening criminal indictment over allegedly false statements to Congress and permitting violations regarding the Federal Reserve’s building renovation. Sunday night, Powell went public, claiming the renovation gripes were a fig leaf for the White House’s displeasure with monetary policy and vowing to fight for the Fed’s independence. (President Donald Trump denies being involved with or knowing about the Justice Department’s move.) Headlines globally are abuzz about the battle’s implications for monetary policy and Fed independence, and the rhetoric is … shall we say … heightened. As always, we suggest tuning down the hyperbole and thinking like markets do. Because from a market standpoint, little is really changing, as stocks’ muted reaction attests to.

Set aside, as always, the politics, personalities and feelings involved. Markets don’t deal with such things—all are sociology. Even when they relate to the Fed head, these things aren’t within markets’ purview. Dwelling on them is a human impulse, but markets look past it all.

Markets move most on surprise. If an event—any event—rapidly raises uncertainty relative to what markets have already been dealing with and pricing in, then it can be a real negative. The effect could be short- or longer-term, depending on its scope and implications.

Crucially, the Justice Department’s move against Powell doesn’t fit the bill. Nor does Powell’s public pushback. If this were all happening out of the blue, against a backdrop of perfect harmony between Trump and the Fed, that would be one thing. But it isn’t. Trump’s displeasure with Powell is old and well-known, dating to his first term. Since Trump took office for the second time, he has griped about Powell’s interest rate decisions and threatened to fire him—and attempted to fire Fed Board member Lisa Cook, whose case is pending Supreme Court review. The construction tiff has been running for months, with a highly publicized photo tour featuring in headlines months ago. Powell’s term expires in May, and Trump long ago dismissed the notion of reappointing him. And it was always an open question whether Powell would continue serving his term as a member of the Fed Board of Governors (which expires in 2028) after being replaced as Chairman. Subpoenas add some flair and more gravitas to the situation, but they don’t change the state of play.

Think about it at the simplest possible level. Last Thursday, we had a Fed head who was on his way out in May and might or might not stay on after that. Today, we have a Fed head who is on his way out in May and might or might not stay on after that.

Some say the risks aren’t immediate, but longer-term, as the White House uses its legal muscle to get the Fed to reduce interest rates—and replace those who don’t comply—ending the Fed’s independence. We see a few points against this. One, that scenario rests on a lot of unproven assumptions. We don’t even know if charges will be brought against Powell. Or what the Supremes will rule on what constitutes “cause” for a president to fire a Fed board member. Two, it isn’t so easy for the president to remake the Fed in his own image. Board terms are long, and five seats on the Federal Open Market Committee go to a cast of regional Federal Reserve Bank presidents (the New York Fed and a rotation of four others). Those positions aren’t presidential appointments. Three, all Fed Board appointments have to win Senate confirmation. Some Republican senators, including some on the Banking Committee, are digging in. (And this is all before midterms potentially change the balance.)

Four, the theory presumes Fed members do exactly what everyone thinks they will based on their prior statements, writings and opinions. But that usually isn’t what happens. Instead, as Fisher Investments Founder and Executive Chairman Ken Fisher often quips, they take “Martin’s Little Pill.” Named after former Fed head William McChesney Martin, it refers to Fed heads’ tendency to act completely different than expected. Former Fed head Arthur Burns called it a pill you take when you become Fed head that makes you forget everything you knew, with the effects lasting as long as you are in office. Martin’s Little Pill explains why former Fed head Ben Bernanke—a Great Depression scholar—forgot to use simple monetary policy maneuvers with a proven ability to boost liquidity during the global financial crisis. It probably explains why former Fed head Janet Yellen simply extended Bernanke’s policies … and why Powell extended Yellen’s. And most of the time, it results in Fed heads not being very consequential. Martin’s Little Pill and institutional groupthink win the day.

As for politicized monetary policy, here is a dirty little secret: The Fed is an inherently political animal. Even being concerned about “independence” is a political act. Might Powell have nudged his crew toward continuing rate cuts earlier last year if the White House hadn’t so vocally wanted them? Might holding have been a political decision to prove a point? Then, too, with politically appointed positions like this, the goal is generally to win reappointment. That will naturally have an influence, however subconsciously, because we are talking about human beings.

Now, we do see some risks downstream here, maybe. If this all leads to a rate cut-happy Fed that quickly cranks the fed-funds target range down where Trump says he wants it, it could rapidly steepen the US yield curve. That would surprise a lot of folks, because conventional wisdom says long rates move with Fed rates, so broad expectations would be for steep Fed cuts to pull down 10-year US Treasury yields. But long rates move most on inflation expectations, and steep rate cuts would probably raise those, driving long rates up. A steeper yield curve is usually an economic positive, but in this case, if it happened rapidly, it could induce a sugar high, causing the economy to overheat and eventually resetting the business cycle.

We aren’t saying this is imminent, probable or a reason to make any related portfolio moves now. This is a watch-and-see situation, a potential risk to be aware of and weigh carefully.

For now, we think patience is the watchword. The S&P 500 barely budged Monday—no sharp selloff. 10-year US Treasury yields rose just a couple of basis points. A smidge. Peanuts. If the Fed’s status had changed hugely, markets would have shown it. Instead, they are telling you the status quo persists.