A U.S. Justice Department investigation on the U.S. Federal Reserve and a combative response by chair Jerome Powell have sharply raised the stakes in a long-running dispute that has put the independence of the world’s strongest central bank openly on the road, investors said.
In a strongly-worded statement on Sunday, Powell disclosed a probe that threatened him with criminal indictment over a constructing renovation project, saying it was a “pretext” to realize political influence over the Fed to lower rates of interest faster.
U.S. President Donald Trump told NBC that he had no knowledge of the Justice Department’s actions, but renewed his attacks on Powell which have grown more frequent and pointed because the Fed has chosen to chop rates more slowly than he would have liked.
The investigation and Powell’s pointed response sharply escalates a row that market observers fear risks upending the independence of the Fed, a bedrock of U.S. economic policy and a cornerstone of its economic system.
It also highlights how heavily the Trump administration’s efforts to reshape institutions from the military to the judiciary are actually coming to bear on a pillar of U.S. financial strength.
The U.S. dollar was down – albeit modestly – against every major currency throughout the Asia session on Monday. Gold shot to a record high, U.S. stock futures dropped and markets priced in a rather higher probability of short-term rate of interest cuts.
The Canadian dollar shot up in value on Monday morning because the U.S. dollar fell.
“Fed Chair Powell has deviated from his previous approach to Trump’s threats, this time selecting to directly address the elephant within the room – that the Fed just isn’t moving rates because the President would love,” said Damien Boey, portfolio manager at Wilson Asset Management in Sydney.
“Gold has strengthened, equities have wobbled, and the yield curve has steepened just a little. These moves have been broadly consistent with the playbook for an attack on the Fed’s independence,” he said.
The power of central banks to maneuver, at the very least in setting rates of interest, without political interference is taken into account a key tenet of recent economics – insulating monetary policymakers in order that they could make decisions for long-run stability.
For investors, trust in U.S. institutions forms a part of the so-called “exorbitant privilege” that the country enjoys in financial markets because the issuer of the world’s reserve currency and recipient of billions of dollars in capital inflows.
Get every day National news
Get the day’s top news, political, economic, and current affairs headlines, delivered to your inbox once a day.
Karl Schamotta, chief market strategist at Corpay in Toronto pointed to “unintended consequences” of leaning on the Fed.
“By attempting to influence the central bank through aggressive legal threats against individual officials, the administration could drive inflation expectations higher, erode the dollar’s safe-haven role, and trigger a pointy rise in long-term bond yields that raises borrowing costs across the American economy.
“Pouring gasoline in all places after which twiddling with matches tends to not work out well,” he said.
‘TECHNOCRATIC FED IS FADING FROM VIEW’
Powell’s pushback is in some sense a parting shot, since his term as chair is as a result of end in May and Trump has already promised his nominee as successor shall be “someone who believes in lower rates of interest, by quite a bit.”
But his stand shall be a frame for any alternative and function a yardstick for shifts within the Fed’s approach.
Richard Yetsenga, ANZ’s group chief economist, said that for the U.S. financial markets of their entirety, the operation of all three of the Fed’s policy arms is more likely to be in flux – rates, the balance sheet and banking sector regulation.
“It’s definitely too early (to inform), however the trends seem quite clear … the technocratic Fed, as we’ve understood it over the past few many years, is fading from view,” he said.
Meanwhile, investors, already beginning to ponder whether their portfolios are over-allocated to the U.S., are on notice in regards to the latest sorts of risks the Trump administration is ushering in.
“The market has shaken off a lot noise across the Fed and Fed independence and I feel might be more likely to do it again, but in some unspecified time in the future things will break,” said Christopher Hodge, chief U.S. economist for French investment bank Natixis.
To be certain, the market moves were small on Monday and a few saw little clear consequence for rates of interest and whilst an indication that Trump actually lacked influence over the Fed.
“Investors won’t be completely happy about it, however it shows actually Trump has no other levers to drag,” said Andrew Lilley, chief rates strategist at Australian investment bank Barrenjoey.
“The money rate will stay what the vast majority of the FOMC wants it to be,” he said, referring to the Federal Open Market Committee, which sets rates of interest.
Still, nagging doubts in regards to the freedom of the Fed to maneuver because it sees slot in the long run are actually planted in investors’ minds.
“I feel I’m still undecided how sustained and adversarial the attack on the Fed is likely to be,” said Vishnu Varathan, head of macro research for Asia ex-Japan at Mizuho in Singapore.
“(But) the Fed independence query is now well and alive and perhaps subject to re-evaluation every few meetings.”
– With a file from Global’s Ari Rabinovitch