Is TACO still testing? Trump played a "fire Powell" exercise with the market

Overnight, rumors surrounding U.S. President Trump possibly firing Federal Reserve Chairman Powell led to a brief but intense stress test in the financial markets. This turmoil lasted less than an hour from the time the rumors began to circulate until Trump publicly denied them, but it was enough to glimpse how the market would react if the independence of the Federal Reserve were challenged.

Wall Street Insights mentioned earlier that on Wednesday, a White House official revealed that Trump might soon dismiss Powell. Following this, reports indicated that Powell would be interviewed on Wednesday, and Trump had drafted a dismissal letter. After the news broke, U.S. stocks and the dollar quickly fell, while short-term government bonds rose as investors bet that a new chairman would align with the president's desire for interest rate cuts, and gold and Bitcoin also increased.

Less than an hour later, Trump denied this possibility, stating that he did not plan to dismiss Federal Reserve Chairman Powell but still hinted that "justifiable reasons" could be feasible. The market then reversed its previous trend.

The core issue of this turmoil lies in what signal the market's reaction conveyed to the White House. Was it a warning to the Trump administration not to act rashly, or did it encourage him, suggesting that the market's reaction was within a controllable range?

Some analysts believe that the market's reaction may have made the government realize that firing Powell is not a panacea for the economy and the markets. However, some observers warn that the market's performance before Trump's denial was not that bad, which could encourage him to take further steps in the future, widening the window of acceptability for the market—this could mark the beginning of a worse scenario for investors.

A Wake-Up Call or Encouragement? Two Interpretations of Market Reaction

Although the market's reaction to the rumors of Trump firing Powell was relatively restrained, it still reflected deep concerns among investors.

During the trading session, the yield on two-year U.S. Treasury bonds fell by as much as 8 basis points, while the yield on 10-year U.S. Treasury bonds dropped by 5 basis points. The Bloomberg Dollar Spot Index shifted from a 0.2% increase to a 0.7% decline, and the S&P 500 index changed from a 0.3% rise in the morning to a 0.7% drop.

Analysts have provided different interpretations of this turmoil.

One viewpoint suggests that the market's negative reaction is sufficient to alert the White House. Wells Fargo macro strategist Erik Nelson pointed out that the reactions of major asset classes may lead the Trump administration to believe that firing Powell is not a cure-all for boosting the economy and the markets. The market's decline clearly indicates that investors' concerns about the loss of the Federal Reserve's independence outweigh their expectations for potential interest rate cuts. However, another viewpoint suggests that this incident may instead encourage the White House to take further action. Derek Tang, an economist at Washington's LH Meyer/Monetary Policy Analytics, wrote in a report to clients: Before Trump denied the reports, the market's reaction was not that bad.

Tang believes that if this was a test balloon to gauge the temperature, then it was successful and may embolden Trump further. Now, the acceptable window for (firing Powell) has changed, and it is moving in a worse direction.

The negative impact on the market has already occurred

Although the turmoil was brief, it touched on a long-standing cornerstone of the U.S. financial system: a central bank free from political interference. Many market participants are concerned that merely discussing the firing of the Federal Reserve Chair is already highly destructive.

Joe Gilbert, a portfolio manager at Integrity Asset Management, stated that the market is viewing this as a credible threat. This is unsettling.

He added that whether this is just a test balloon used by Trump to gauge market sentiment remains to be seen, but he believes the legal obstacles would be significant.

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab & Co., argued that merely threatening to "fire" is a bad precedent, sending the signal that "I am willing to break all precedents to get what I want."

Major Wall Street firms have also expressed serious concerns. JPMorgan CEO Jamie Dimon emphasized during this week's earnings call that the continued independence of the Federal Reserve is absolutely critical, as intervening in the central bank often leads to adverse consequences.

For investors, this farce highlights potential policy uncertainty in the coming months.

Jordan Rochester, Head of Macro Strategy at Mizuho International Plc., wrote in a report that uncertainty surrounding the independence of the Federal Reserve will mean lower market confidence, more pricing for rate cuts, a weaker dollar, and higher term premiums.

George Saravelos, Global FX Strategist at Deutsche Bank, predicted that if Trump really forces Powell to resign, the trade-weighted dollar could drop by at least 3% to 4% within the next 24 hours, while the fixed income market could see a sell-off of 30 to 40 basis points.

However, for some seasoned traders accustomed to the chaotic information flow of the Trump administration, this is just another day.

Leah Traub, Partner and Portfolio Manager of the Global Rates Team at Lord Abbett, stated that if you try to trade around these headlines, you will go crazy. We chose to stand still