Rumors have emerged suggesting that the President has looked into the possibility of firing Jay Powell as Fed Chair, which raises many questions. Can he? Should he? What would be the consequences for trying to do so? And should the market be selling off as much as it has?
It is not at all clear the President can fire Powell. The Federal Reserve Act allows a President to fire a Fed chair for “cause.” Firing for cause would generally require legal misconduct, such as fraud, or a serious ethics violation. But cause would certainly not include a difference of opinion on whether the Fed should or should not hike policy rates, a decision made by a vote of the entire FOMC and not unilaterally by the Chair. Moreover, although the President has the explicit authority to fire Powell for cause, he implicitly does not have the right to fire Powell just because he feels like it and wants him out. Indeed, the market’s view has always been that the Fed Chair is appointed to have quite a bit of independence so that he/she can make difficult decisions without the fear of political retribution. Removing Powell because he disagrees with the President over rate hikes would clearly establish the Fed chair as reporting to him, which is contrary to the essential independence of central banks. Nonetheless, the right to fire Powell could be tested in the courts, since in our democracy, we accept that appointed officials must be subordinate to elected officials. However, the Fed passes this test since it was established by an act of Congress and does report to Congress.
Whether legal or not, it is highly questionable whether Trump should fire Powell even when viewed from the perspective of Trump’s political self-interest. Doing so would mean Trump has taken explicit responsibility for monetary policy and can no longer blame the Fed if the economy behaves badly. It is always useful having a scapegoat and Trump has set up Powell for precisely that role, if Powell errs. If the economy performs poorly, Trump has Powell to blame.
Moreover, attempting to fire Powell could prove highly disruptive to markets and the economy, especially if it takes some time for the Supreme Court to rule on the legality of such an action. Even if Trump names a replacement fairly quickly, presumably someone far more inclined to keep interest rates low, the market’s reaction could be highly unfavorable. Stocks might rally at first in response to the prospect for fewer rates hikes, but I suspect the bond market would sell off fairly sharply, especially long term bonds, out of concern that inflation will take off. Any effort by the new chair to add liquidity to the financial system to push rates down would only accentuate the market’s concerns, just as happens in assorted banana republics where governments finance themselves by printing money.
A Supreme Court test can be avoided even if Trump tries to fire Powell, if Powell chooses to walk away to avoid the legal confrontation. Even so, Trump would be assuming responsibility for policy and would need to name a replacement, a person who would most likely be seen as Trump’s man and not the independent leader markets need from the Fed. It is doubtful this would play well in the market. So there are good reasons for Trump to avoid the turmoil that would ensue if he fires Powell, despite the President’s tendency to charge ahead based on his own views and against the counsel of advisors. And having hiked rates despite the President’s public expressed desire for no change in policy, the Fed is unlikely to move again until incoming data makes an unambiguously strong case that more rate hikes are warranted. So the President is likely to get some of what he wants. Even so, expect more fireworks when it seems likely the Fed could move again.
Lastly, the stock market has been in a tailspin for several weeks, despite an economy that continues to perform quite well. What this demonstrates most clearly is that stocks can be highly volatile because investor psychology is fragile. In 1987, stocks declined by more than 22% in a single day, yet the economy didn’t lapse into recession. The current decline is also highly unlikely to cause a recession, not when firms are still trying to fill 7 million job openings, holiday shopping appears to be quite strong, and the data shows nothing but solid growth. The political environment is awful, even toxic, but political infighting in Washington has never caused a recession. It makes little sense that it would. Rather, we have front row seats to watch a group of politicians behave badly. Personally, I would like to exit this theater, but that doesn’t mean I’d exit the market. As suggested by Warren Buffett, “… be fearful when others are greedy and only be greedy when others are fearful.” I think that’s a better model for guidance on how to operate.