Institute Alert

• President Trump has clearly and openly expressed disagreement with Federal Reserve (Fed) Chair Jerome Powell.
• However, we still believe that the actual likelihood of the president proceeding with a removal of Powell from the Fed is low, due to legal and institutional barriers.

• We believe such a dismissal remains unlikely, but the recent uncertainty about how such a showdown may end has pushed equities, U.S. Treasury securities, and the U.S. dollar lower in value.

Financial markets were volatile again on April 21. Bond prices fell and the U.S. dollar slid against major currencies. The S&P 500 Index lost approximately 2.4%. On a day of scant news, investors appeared focused on a speculation from the previous week — namely, that President Trump may try to dismiss Fed Chairman Powell.

The Federal Reserve Act allows for the president to remove any of its governors, including the Chair, for cause. There is also a legal precedent from a 1935 Supreme Court case, Humphrey’s Executor v. United States, which affirmed that certain independent agency heads (like the Fed Chair) can be removed only for cause. What constitutes cause (as opposed to mere disagreement over policy decisions) is a key consideration in the current debate. Moreover, President Trump recently fired one commissioner from each of two independent federal agencies, the National Labor Relations Board and the Merit Systems Protection Board. These are two multimember boards, as is the Fed, so dismissing these members appears to challenge the precedent. The Supreme Court is currently reviewing these two dismissals and may reach a decision this summer.

Attempting to remove a Fed chair would most likely trigger financial market questions about the Fed’s credibility as an independent institution.

• The Fed chair could sue to retain his position, arguing the removal violates the Federal Reserve Act. Chair Powell has made remarks that he would do so.
• The courts would scrutinize whether the president demonstrated valid cause, further extending a potentially complex legal battle.
• Financial markets would likely react negatively to the perceived politicization of the Fed, which likely would cause further deterioration in value of U.S. equities, U.S. bonds, and the U.S. dollar.

If the Fed chair were to come under the control of the executive branch, investors could try to sell U.S. debt, attempting to diversify capital toward other perceived safe-haven assets (like European or Japanese bonds), which could also undermine the credibility of the U.S. dollar and destabilize the U.S. economy in a deeper way. But that premise seems to us far from certain.

The Fed has a statutory dual mandate to promote stable prices and full employment. We believe that mandate has become the basis for the Fed’s reputation and that Congress has a direct interest in preserving the mandate. What’s more, we think it very unlikely that the other 11 voting members of the Federal Open Market Committee suddenly will abandon that reputation. It is worth remembering that five of those 11 remaining voting members are regional Fed Bank presidents, whom the president neither appoints nor controls. We do not profess to be legal experts but also see no reason to jump to the conclusion that the Fed is about to lose its most important reputation.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.

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