Why the Fed’s Independence Matters to Markets, the Economy, and Your Wallet

Key Takeaways

• The White House is ramping up its pressure on the Federal Reserve, with President Trump announcing that he plans to fire Governor Lisa Cook.
• Trump has levied increasingly harsh criticism at Fed Chair Jerome Powell this year for not lowering interest rates, and he has speculated publicly about removing Powell.
• A politicized central bank opens the door to higher inflation, higher interest rates, and a loss of confidence in the American financial system.

The Federal Reserve’s independence is under fire again, and alarm bells are ringing louder this time around. Late on Aug. 25, President Donald Trump said on social media that he intends to fire Federal Reserve Governor Lisa Cook following allegations of mortgage fraud. No charges have been filed against Cook, who said she will fight her removal.

This is the latest development in months of escalating pressure on the central bank from the White House. Earlier this summer, financial markets whipsawed after a White House official suggested that Trump would likely fire Fed Chair Jerome Powell, before Trump himself walked back the statement shortly afterward.

That follows a barrage of criticism of Powell from the president earlier this year. Trump has called for lower interest rates and warned that the economy could slow if Powell doesn’t cut rates soon. Some on Wall Street view the threats to Cook’s position as Trump’s latest attempt to influence monetary policy.

“Trump’s decision underscores a broader strategy: He has been consistently unhappy with the Fed and eager to reshape the institution on his own terms,” wrote Natixis economists on Tuesday. A potential court case over Cook’s removal could “drag the Fed into a high-profile legal and political fight, with markets watching closely, and could itself erode confidence in the institution’s insulation from partisan politics.”

Morningstar’s chief research and investment officer, Dan Kemp, adds: “While the matter will likely be settled in court, this exceptional intervention in the running of the Fed may have far-reaching consequences for investors. With two openings among the governors, a majority of the board will be Trump appointees. President Trump has long made clear his view that interest rates should be lower in the US. It is therefore likely that any new appointees will be aligned to that view.”

Risks of a Politicized Fed

Analysts say that lowering interest rates prematurely—and ousting the head of a federal agency designed to operate independently from the executive branch—could mean trouble down the line. Doubts about the Fed’s credibility could lead to higher inflation and long-term interest rates, meaning higher borrowing costs for businesses and higher consumer costs for credit cards, auto loans, mortgages, and more. That’s to say nothing of the impact higher inflation has on households’ day-to-day living costs.

Less tangibly, a politicized Fed could undermine faith in the United States among global investors as a destination for their capital (which the government relies upon to finance its debt).

Trump’s rhetoric has triggered alarm bells for market watchers, many of whom believe that Powell’s termination would destabilize global financial markets, undermine the credibility of the US dollar, and set a dangerous precedent of a central bank that can bend under political pressure.

“I am very, very concerned,” James Angel, an associate professor of finance at Georgetown University’s McDonough School of Business, told Morningstar earlier this year. “This is not an isolated one-off of a politician grumbling about the Fed.”

Trump isn’t the first president to be critical of Fed policy. But while the consensus is that he wouldn’t attempt to force Powell out of his role, the president has repeatedly upended political norms.

Can Trump Fire Powell?

The heightened tensions come as the Fed is already in a tough spot. The landscape for US policy (especially trade policy) has changed dramatically over the past few months. Central bankers “don’t have a lot of clarity on what’s going to happen,” Derek Tang, cofounder of monetary policy research firm LHMeyer, explained this spring. “Powell and his colleagues feel that the best strategy to get through this is to keep a steady hand and sit tight for a little bit,” he said. Meanwhile, Trump is pushing hard for lower rates to help boost the economy.

But Powell has been adamant that the Fed will not bend to political pressure. Last fall, he emphatically stated that he will not step down from his role if asked, noting that the president is “not permitted under the law” to remove him. He has also emphasized that the central bank will not rush to ease rates, even as markets whipsaw and the outlook for growth and inflation worsens amid the trade war. “For the time being, we are well-positioned to wait for greater clarity before considering any adjustments to our policy stance,” Powell told the Economic Club of Chicago.

The Fed has held its benchmark interest rate in a range of 4.25%-4.50% since the beginning of the year, amid sticky inflation and an uncertain outlook for tariffs and growth. The central bank eased the policy rate by a full percentage point last fall.

Tang explains that an impending Supreme Court case concerning whether Trump can fire a federal official like Powell is adding to the unease. “There’s always been this assumption that the Fed is an independent agency,” he said. “That assumption is now being tested, and that’s making a lot of people very uncomfortable,” especially in financial markets.

The Fed has been criticized by past administrations, but analysts say the severity and consistently of vitriol in this case is alarming. “Trump is quite different,” added Tang. “We have had presidents in the past who’ve applied various amounts of pressure on the Fed, but not to the same extent.” He says it’s not a given that Trump will remove Powell, even if the Supreme Court rules that he has the authority to do so. “Trump is not necessarily going to go through with it, because the financial markets would basically collapse,” he said. He points to the president’s about-face on tariffs once the bond market began showing signs of stress.

Inflationary Risks of a Compromised Fed

The Fed is accountable to Congress, but it makes monetary policy decisions related to its mandate—low, stable inflation and maximum employment—separate from both the legislative and executive branches. That’s by design.

“Country after country has discovered that central bank independence is essential for flighting inflation,” said Angel. “When you allow politicians to control the money supply, they have a nasty habit of printing too much money.” In the short term, the Fed can lower interest rates by buying government bonds, which would push down yields and lead to lower rates, more lending from banks, and more spending by households and businesses.

But there’s a downside to that. “Unfortunately, as that money works its way through the economy, all that extra money chasing the same amount of goods and services is going to push the price of those things up, and that makes inflation worse later on,” Angel explained. “Printing more money is exactly the wrong thing to do at this time.”

Inflation is difficult to correct—the last few years of stubbornly high price pressures are evidence of that. However, higher prices weigh on consumer sentiment and are frequently used as a touchpoint by politicians. “The Fed is always between a rock and a hard place,” Angel said. “If they print too much money, they cause inflation. If they print too little, they cause the economy to stagnate.”

US Credibility Undermined

Another potential consequence of Powell’s removal would be an erosion of confidence in US assets as reliable, safe havens for international investors. Angel of Georgetown summed it up this way: “The US dollar and the US Treasury bond are financial services that we offer the entire world. And what Trump is doing is trashing the basic export of the US.”

If the United States’ financial and political system is perceived as unstable and critical policies are unpredictable, foreign investors may demand a higher return on their money to compensate for those risks. Powell seems to have alluded to this issue in recent remarks, saying that if uncertainty remains high, “that would weigh on investment just in general” and the US would be “less attractive as a jurisdiction.”

Morningstar’s Kemp says: “US assets have long been the standard against which the risk all other assets are measured,” meaning they carry a lower risk profile than they otherwise would. “The perception of a politicized central bank coupled with mercurial policymaking could weaken this status, reducing the premium valuation of US assets.” He adds that despite the risks, “it is important that investors do not overreact to this latest news.”