Trump and Powell spar anew in major Fed test

The last thing U.S. markets need right now is a war of words between the White House and the Federal Reserve, yet they may have to brace for increasingly testy exchanges over the days and weeks ahead.

President Donald Trump is currently refusing to back down on last week's sweeping tariff hikes, but the resulting Wall Street tailspin will make it increasingly uncomfortable for him to hold the line, partly because of how Main Street is starting to feel.


Sure, he is arguing that his economic restructuring will take time - delivered in years rather than days - and Americans just need to be patient. But market implosions of the scale seen over the past week can feed on themselves, potentially leading to recessions that economies can take years to recover from.

What better time for the Fed to ride to the rescue?

On cue, just before Fed boss Jerome Powell stood up to speak on Friday, Trump's social media account blared: "CUT INTEREST RATES, JEROME, AND STOP PLAYING POLITICS!"

In a super-sensitive moment, as U.S. markets tanked and the president heaped on pressure, Powell carefully avoided being drawn into a squabble and instead concentrated on the difficulty the central bank now faces navigating both the inflationary and recessionary impacts of a global trade war.

The basic message was that the Fed is not going to act with haste, preferring to wait until the policy picture clears up before making any decisions. Powell clearly wasn't shooting from the hip here, as the majority of his Fed board colleagues have been saying exactly the same thing.

Yet, with many investors assuming the Fed is the only thing standing between a trade shock and a recession, Powell's equivocation was unnerving - and this only deepened the selling on Monday.

But the Fed chair may have actually laid out a more blunt challenge to the administration's thinking than it appeared at first glance. Some banks said artificial intelligence models indicated that Powell's speech was one of the most hawkish since 2022.

And other Fed watchers reckoned markets still haven't fully appreciated Powell's determination to keep long-term inflation expectations in check, leaving open the chance that the Fed may opt to lift rates.

For this, they point to an ambiguous Powell line from Friday: "It is too soon to say what will be the appropriate path for monetary policy."

Trump clearly is not backing down. He may have avoided using all caps this morning, but with U.S. stock futures down another 4% ahead of the day's open, Trump wrote on his Truth Social platform: "The slow moving Fed should cut rates."

THE FIRST BLINK

During the first Trump administration, the president regularly lambasted the Fed chair whom he himself appointed, once calling him "Clueless Jay Powell". If this history is any guide, then the standoff between Trump and Powell could run for months.

The big question is whether this verbal jousting ultimately matters.

The fragility of investor confidence right now makes it seem quite material.

While the stock market would clearly embrace the prospect of a Fed rescue akin to the pandemic-era easing, cutting rates with above-target inflation and the prospect of a re-acceleration of import prices could mean that Treasury yields will respond perversely and rise.

Look at what happened today. Even though the wildly volatile stock market continued to weaken into bear market territory, Treasury yields reared back up, with 10-year yields retracing most of the losses since Wednesday's tariff announcement.

Though, ultimately, concern about the growing political pressure on the Fed to bail out the government may unnerve Treasury holders and overseas investors already wary of fraying U.S. institutional rigour.

In an extreme scenario, White House pressure on the operationally independent Fed could lead to sackings and new appointments to the central bank's voting board. Some fear that the White House could even use a politically captured Fed as a weapon in widening trade and geopolitical standoffs.

While that is certainly not anyone's base case scenario, overseas officials see it as a potential nuclear option.

All these fears may jar foreign investor confidence in both the dollar and the Treasury market just when overseas capital may be needed to stabilize shaky domestic markets.

For some economists, such as Tim Duy at SGH Macro Advisors, it's a question of who blinks first.

"If Powell blinks too soon, central bank independence is gone as Trump has provided a blueprint to use market chaos to force the Fed's hand," Duy, a former Treasury economist, wrote on Monday. "We don't think Powell is going to easily blink. It's not so much that there won't be rate cuts at some point, it's that there will be a lot more pain between here and there."

Stay tuned for the next round of the sparring match.

The opinions expressed here are those of the author, a columnist for Reuters.