You can say this about Donald Trump: He’s not parochial at all when it comes to his targets. After a busy few months of battling U.S. trading partners, splitting up asylum-seeking families at the border, and spatting with NATO allies, he’s now picking an unprecedented fight with his own central bank.
The U.S. President declared his disappointment with the Federal Reserve in a CNBC interview on Thursday, saying he was against a strong dollar and “not thrilled” about more hikes in interest rates. He sent the greenback into a further tailspin on Friday with a series of angry tweets in which he declared that “the United States should not be penalized because we are doing so well. Tightening [interest rates] now hurts all that we have done.”
For Fed chairman Jay Powell, the message is about as subtle as waking up next to a bloody horse’s head: Raise rates at your peril, Mr. Powell.
The friction between the White House and the Fed adds to the uncertainty over what markets can expect on the interest rate front over the next few months. More disturbingly, it demonstrates how little the President understands about the way an independent central bank is supposed to work.
In developed countries, presidents and prime ministers don’t criticize central bank policy – at least, not in public – for an excellent reason. The whole point of an independent central bank is to insulate elected politicians from unpopular but sometimes necessary decisions, such as tightening policy during periods of increasing inflation. Any politician who attempts to publicly direct a central bank risks owning the fallout from its decisions.
Mr. Trump’s outbursts on rates are “the stuff of a relatively unsophisticated administration that appears to be unschooled or uncaring toward the reasons for why things have tended to evolve the way they have over time,” Derek Holt of Bank of Nova Scotia wrote in a note.
To be sure, the President’s insistence on low rates isn’t just about ignorance. It also underlines the growing tension in Washington. The administration is doing everything it can to juice U.S. growth before mid-term Congressional elections. The Fed has been gradually raising rates to dampen the inflation that goes with an economy operating near full capacity. The President clearly disapproves of its attempts to cool things off, especially so close to a crucial vote.
This sets up a fascinating tug of wills. Mr. Powell’s term as Fed chair lasts until 2022. Under the Federal Reserve Act, he can only be removed by a president “for cause.” Exactly what that means is open to debate, but refusing to obey Mr. Trump’s tweets falls short of any reasonable definition. Any attempt to remove Mr. Powell would not only be politically explosive, but doomed to fail. Even Mr. Trump praised the Fed chair as a "very good man” on Thursday.
Instead of a frontal assault, Mr. Trump could try to influence the Fed’s decision by appointing a loyalist to the empty seat that remains on the Fed’s seven-member board of governors. However, any appointment would need Senate confirmation, and the appointee would amount to only a single vote on the 12-member Federal Open Market Committee, which decides on rates increases.
All of this means the President’s blustering on rates is likely to have little practical effect. It may actually backfire in the short term. The Fed “will need to state their independence by tightening in the September meeting to prove a point,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management. Looking further out, “a faster pace of rate hikes may be needed to reinforce the Fed’s independence,” said Dennis Debusschere, head of portfolio strategy at Evercore ISI.
Faster rate hikes could threaten the stock market, because they would encourage higher bond yields and make bonds more appealing, especially to investors fretting about the potential for a global trade war. Mr. Trump ratcheted the market’s anxiety even higher on Friday by threatening to slap tariffs on all Chinese imports.
But he also demonstrated a certain level of confusion about the reasons for that trade war. “China, the European Union and others have been manipulating their currencies and interest rates lower, while the U.S. is raising rates while the dollars gets stronger and stronger with each passing day – taking away our big competitive edge,” he tweeted.
What Mr. Trump doesn’t seem to grasp is that U.S. rates and the U.S. dollar have been going higher largely because of the wave of stimulus he has unleashed through massive tax cuts. He could help to bring about lower rates and a lower greenback, but only at the cost of slower growth.
“Not only do we appear to be heading for a trade war, but it also looks like currencies are about to be brought onto the field of battle as well, as the U.S. administration tries to limit the effects of its own fiscal stimulus,” said Michael Hewson at CMC Markets. To put that another way, this is an administration that seems willing to pick a fight with anybody – including itself.