What happens if Trump fires Jerome Powell?

Not the only solution to Trump’s problem

The problem is that lower rates alone won’t solve the problem. Tariffs are intended to discourage imports and promote domestic industry, but the US does not have idle capacity waiting to come online to fill the gap left by reduced imports from China and elsewhere. So, in the short term, either import volumes will stay the same and prices of manufactured goods will rise (because of the tariffs), or volumes of imports will fall leading to both shortages and price rises. However you look at it, these policies will push up prices. This puts the Fed in a difficult spot as it needs to keep rates higher to contain inflation and allow some (but not too much) demand destruction.

The more Trump tries to intervene and pressure the Fed to cut rates, the more the Fed is likely to lean hawkish to preserve the optics of independence, so staying quiet is probably the best strategy to actually achieve lower rates. However, by complaining, Trump is creating a scapegoat in Powell if growth takes a nosedive, so it may be a politically astute move to leave him in office to be the fall guy.  

What if Trump succeeds?

Putting aside questionable legalities, what would the implications be for market prices if Trump were to install a more complicit chair?

The first thing to expect is a lower Fed funds rate than otherwise. If interest rates are persistently ‘too low’ this will push growth higher but also stoke inflation so long maturity bonds need to yield more to compensate. Lower short-term yields and higher long-term yields means the yield curve is steeper.

Equity wise, lower rates should help juice corporate earnings, encouraging more spending by consumers and reducing the cost of investment for businesses. However, earnings are nominal, so while earnings would grow, they won’t necessarily look as good in real terms. As an investor, it is important not to be drawn in by the money illusion of high earnings growth in a high inflation economy and instead think in terms of purchasing power.

It would also likely mean a weaker US dollar. There are several factors that drive currencies. Four big ones are growth, inflation, interest rates and credit worthiness. Currencies are a relative game but if we assume no change elsewhere in the world, which is not realistic but let’s go with it, then the change in growth differential might go in USD’s favour in this instance. However, the other factors would be squarely negative for the dollar.

So far, none of this sounds great, but something positive could come from it all. Low rates and high inflation could help the US outgrow its burgeoning national debt pile. In the past, ‘inflating away’ debt has typically been an important part of the solution when debt to GDP ratios become too stretched. Reducing budget deficits and debt ratios through spending cuts is politically very difficult when the bulk of spending is on entitlement payments and healthcare for an aging population, so reducing the value of both spending and outstanding debt in real terms via inflation might be the only feasible course of action.

But what are the chances?

That bring us to the question of how likely any of this is. We would note that, in his last term, the Senate turned down two of Trump’s nominations for the FOMC, so there are firewalls in place to prevent him from appointing someone too ‘out there’. Furthermore, the 90-day tariff pause on 9 April happened because Treasury yields spiked almost 0.5% in just a few days. If Trump fires Powell, the market reaction would be similar, and Trump knows this.

Overall, while this is a risk we must be alert to, it is just a risk rather than a likely outcome at the moment. Despite several shrill articles in the media, this view is seemingly shared by most investors as the dollar remains expensive and the Treasury yield curve is still flatter than long term averages, although it has steepened recently. So, if we edge closer towards this scenario, there could still be a long way for the market to move.