In his second term, President Donald Trump has attacked Federal Reserve Chair Jerome Powell and his underlying institution with little impact on the markets. That may soon change as investors digest the administration’s criminal investigation into Powell for allegedly lying to Congress.
It is about time. For much of the past year, investors and commentators have put surprisingly little thought into the long-term implications of the president’s threats against the Fed, including his attempt to fire Fed governor Lisa Cook in August for alleged mortgage fraud, which she denies. This despite the potential for that case to create a legal path for Trump to fire other Fed governors and install his loyalists.
Complacent investors are either assuming the court will rule against the administration or crossing their fingers that Trump will restrain himself if he does win his case against Cook. The Justice Department issued subpoenas to Powell on Friday as part of an investigation into whether he allegedly lied to Congress. Yet if the court doesn’t strongly rule in favor of the Fed, investors will likely regret having given so little attention to this obvious risk.
To date, Trump in his second term has only had the opportunity to choose one of the seven voting members of the interest rate-setting Fed board, the uber-loyal Stephen Miran. Miran’s term ends this month. Not until Powell’s term as a governor ends in 2028 will Trump get another shot to appoint a voting governor. So if Trump wants to make additional appointments, governors will have to resign or be fired for cause. Trump is edging for the latter.
Ironically, the new criminal investigation into Powell is likely to diminish Trump’s ability to gain influence on the voting board. That is because Powell is now likely to stick around as a voting member rather than depart the Fed when his chair term ends in May.
Traditionally, the chair retires immediately rather than serve out their optional tenure as a governor. Neither Paul Volcker, Alan Greenspan, Ben Bernanke, or Janet Yellen served a day beyond their term as chair. The investigation into Powell almost guarantees he will break this chain. He nearly said as much in a public statement on Sunday: “I will continue to do the job the Senate confirmed me to do, with integrity and a commitment to serving the American people.”
The betting platform Polymarket shows a more than 55% chance that Powell will stay on the Fed board after his chair term ends. Since last week, the odds that he will no longer be on the board by year end have fallen from 70% to less than 60%.
That the December odds are higher than the May odds reflects an expectation that Powell will retire if the Supreme Court rules in Cook’s favor after his term ends in May, or that Trump will fire him. Presumably, the odds of Powell being fired haven’t fallen, given the new investigation into him. So the reduction in odds more likely reflects a greater conviction that Powell will insist on staying on the board through years end.
But if the court does allow for the removal of Cook, Trump will more easily remove Powell. Congress can hardly be expected to push back.
That means that by June, which is when Powell must depart the chair, at least three of the seven permanent voting members, including the chair, could be ultradovish Trump loyalists. Trump may try to expedite the firing of governors after a favorable court ruling to get ahead of a Senate flip in the November midterms. His team has likely scoured applications, taxes, investments, expense claims, and more of all the current governors. If there is any smoke, Trump will fire.
The odds look to be in Cook’s favor. But the important question isn’t whether she wins the case, but how strong of a message on constraining presidential Fed firings the court will make in its decision. What if they acknowledge the president can fire for cause, but simply argue that infractions must occur when a governor is in office? What if Cook wins only because she wasn’t given due process in her firing? Both rulings are bad for markets—Trump would retain the power to fire other governors.
The only constraint to Trump packing the Fed will be the markets. If the court rules in Trump’s favor, the best-case scenario is that markets crash, deterring him from replacing other Fed governors. The worst-case scenario is that markets cyclically tolerate a packing of the Fed with dovish loyalists, only to pay an even worse structural cost when the cycle demands rate hikes that the new Trump Fed resists. Even if you believe Trump will give his loyal Fed cover to raise rates when required, that will likely only happen after punishing market action. In either case, investors suffer.
To avoid the risk of a higher future cost of capital in the U.S., the court should clearly affirm Fed independence. Investors are waiting for the Supreme Court’s oral arguments in the Cook case on Jan. 21 for an indication of what the justices are thinking.
If investors whiff any sense that Trump will be granted a liberal scope to fire governors for cause, this month could be the beginning of the next bear market, if not a market crash.
About the author: Mike Harris is the founder of Cribstone Strategic Macro and the director of Syracuse University’s Whitman School of Management London program.