Markets Tumble 0.8% on Trump Powell Removal Rumors

Yesterday, markets experienced a significant drop following reports that President Trump might remove Federal Reserve Chair Jerome Powell from his position. This news sparked a brief period of turmoil, with the S&P 500 losing 0.6% and the Nasdaq declining 0.8%. However, the markets quickly rebounded after Trump downplayed the idea of firing Powell, indicating the sensitivity of Wall Street to threats against the Fed's independence.

Analysts from Goldman Sachs, Deutsche Bank, and UBS published notes assessing the potential impact if Trump were to appoint a "stooge" to replace Powell. The chaos extended to the bond markets, with a notable steepening in the yield curve as investors increased the likelihood of a near-term rate cut. At one point, a rate cut by September was priced as an 80% chance, up from 57% the previous day. The 2-year yield dropped by 8.2 basis points to 3.86%, while the 30-year yield surged by over 10 basis points in under an hour to an intraday peak of 5.07%.

There is widespread agreement that replacing Powell with a Trump loyalist would be detrimental, especially for U.S. bonds. Macquarie’s Thierry Wizman and Gareth Berry noted that a fiscally compromised Fed could lead to higher long-term inflation expectations, making the U.S. Treasury yield curve more prone to steepening.

The incident raised questions about whether the president has the legal right to fire Powell. While the law currently does not allow for such an action, Trump has been building a case that Powell's supervision of renovations at the Fed HQ building is corrupt, hoping to fire him "for cause."

Goldman Sachs highlighted a paper from May featuring an interview with former Fed Vice Chair Richard Clarida. Clarida warned that if the Supreme Court changed the law to make it easier for Trump to remove Fed chairs, it would introduce significant uncertainty into financial markets and likely lead to higher inflation expectations. A noncredible chair would face resistance from within the Fed, as the committee structure acts as a check on the power of any one individual in setting policy.

Paul Donovan of UBS agreed, stating that an obvious political stooge would likely be ignored by markets and the Fed itself. However, a superficially independent chair acting as the president's spokesperson within the Fed would be more troubling.

The market volatility underscores a new reality where there is genuine uncertainty over whether the Fed will operate independently once Powell leaves in May. Clarida noted that the odds of the Supreme Court overturning the relevant court case to nullify Fed independence are no longer zero.