How Trump’s war on the Federal Reserve could do serious damage

Pity the bond trader without Truth Social on their phone. All it took was one after-dinner missive, fired off by the president on his social network, to turn the White House’s tussle with the Federal Reserve into something more worrying. On August 25th Donald Trump posted a letter saying he had fired Lisa Cook, a Fed governor, for alleged mortgage fraud.

Although presidents can sack Fed officials, they can do so only “for cause” and none has used the power before. Ms Cook has not been charged with a crime, let alone convicted of one. The claim—that she listed two homes as her primary residence—was first made by Bill Pulte of the Federal Housing Finance Agency, who has made similar claims against others (none yet leading to legal charges). Ms Cook has pledged to fight the firing in court and, in the meantime, to stay in her post.

The move is a remarkable escalation in Mr Trump’s campaign against independent central banking. The Fed was mostly peripheral in his first term, occasional grumbles aside, but has become a bogeyman in his second. He has loudly and publicly demanded interest-rate cuts, and dubbed Jerome Powell, the chairman, “too late” for failing to provide them. He has toyed with sacking Mr Powell, and for a spell tried to use the costly renovation of the Fed’s headquarters as a pretext. He blames the Fed for constraining the housing market with high interest rates. “Once we have a majority, housing is going to swing,” he said recently.

So far, Mr Powell and the Fed have largely ignored the ruckus. There have been no interest-rate cuts since December, though one looks likely in September. Behind the insouciance lies confidence in the Fed’s legal protections: governors have long terms and are hard to evict. The Supreme Court recently carved out the central bank in a ruling making it easier for presidents to fire agency bosses. But the attack on Ms Cook raises the pressure. Her term is due to run until 2038; successfully replacing her with a Trump loyalist would leave these defences looking fragile.

Three pressure points will determine how much damage Mr Trump manages to do. First is the coming court battle over Ms Cook. Proving that her alleged misdeeds merit a sacking will be difficult. She filed the paperwork in question in 2021, while a private citizen. Demonstrating wrongdoing may also mean showing that any misrepresentations were deliberate. Few expect a swift resolution. Betting markets place odds of just 10% on her being successfully removed by the end of September, rising to 25% by the end of the year.

Second is a vote, carried out every five years, by the seven Fed governors to approve regional Fed branches’ choice of presidents. A rotating cast of five regional Fed presidents rounds out the 12-person Federal Open Market Committee (FOMC), which sets interest rates. That vote comes early in 2026. If Ms Cook is pushed out, and the Senate confirms replacements for both her and Adriana Kugler, another Fed governor who has recently resigned, then in principle four of the seven Fed governors will be Trump appointees, and could insist on sympathetic regional presidents. However, even in that scenario, such blatant interference is unlikely. Christopher Waller and Michelle Bowman, the two governors appointed during Mr Trump’s first term, are technocrats.

The third pressure point is the end of Mr Powell’s term. After first seeming to narrow the field, Mr Trump has floated a longer, zanier list of names. Among the main contenders, Mr Waller, who predicted against consensus that America could cool inflation without a recession, would be the most reassuring pick. If Mr Trump opted for a loyalist such as Kevin Hassett, one of his economic advisers, the FOMC’s ability to outvote him would protect against meddling—unless it was undermined by more Cook-style ejections.

The last president to try seriously to fiddle with the Fed was Richard Nixon, who leant on Arthur Burns, then chair, to lower interest rates ahead of the presidential election in 1972. It was a calamitous move. Inflation rose even before the oil shock of 1973, and took another decade to contain. Thomas Drechsel of the University of Maryland estimates that a bout of political pressure about half as intense as the Nixon effort, applied for six months, could raise prices by 7% over a decade.

And Mr Trump has taken a far more brazen approach to pressuring the Fed than even Nixon dared. Markets have become more sceptical of America during his second term. The dollar has fallen by 9% against other rich-world currencies. Gold, a store of value that does not rely on the credibility of any central bank, has soared. Although short-term Treasury yields have fallen as the American economy has softened, longer-term yields have stayed high (see chart), reflecting investor concern about America’s debt load and threats to economic institutions such as the Fed.

At the same time, stocks have countered the gloom, and are at all-time highs. Stocks, Treasuries and the dollar all fell after Ms Cook’s “sacking” was announced, but the scale of the moves was trifling. Taking threats to Fed independence seriously would almost certainly warrant a far sharper response. So why the relative calm? In part, because Mr Trump has many battles still to fight. Securing a sympathetic FOMC majority would require successfully persuading courts to allow him to sack Ms Cook, pushing several lackeys through confirmations in the Senate and convincing several more independent-minded governors to demand a pliant slate of regional Fed presidents.

But investors’ sangfroid also creates a problem. Mr Trump’s habit is to keep pushing until he meets resistance. Markets are relaxed because they expect the president to back down, yet market discipline is probably needed to force a rethink. And although a full-on Fed takeover is only an outside possibility, the president’s war on central banking could still do serious damage. For one, he has already broken a decades-long norm that Fed independence is sacrosanct. If political control of the Fed becomes a consistent Republican demand across election cycles, the politicisation of monetary policy is near-inevitable.

Hurting confidence in America’s economic institutions matters, too. The Fed has already been shaken by its failure to anticipate post-pandemic inflation. Higher interest rates were able to tame rising prices without a recession in large part because people trusted the Fed would be able to get inflation back to its target of 2%, preventing a 1970s-style wage-price spiral. Even under normal circumstances, pulling that trick off again would be difficult, for Americans are now primed to expect inflation. Doing so with a politically compromised central bank would be harder still.

A loss of faith in the Fed would also cause problems in the bond market. America now runs a fiscal deficit of 7% of GDP, three times as high as in Nixon’s day. Government net debt sits at around 100% of GDP. Persuading investors to swallow such borrowing is never straightforward. The sales pitch becomes near-impossible if the Fed cannot be trusted to keep inflation in check. So far, America has remained attractive because of its status as a haven, and because most other rich countries are also borrowing more. But investors do have alternatives, and with a few more Truth Social posts they may start to turn to them. ■