Senior central bank reporter: Preparing for the "end of Federal Reserve independence," while the market has not yet realized it

According to CCTV News, on August 25 local time, U.S. President Trump publicly announced in a letter to Federal Reserve Governor Lisa Cook on his social media platform "Truth Social" that she was immediately dismissed.

This is an unprecedented move in the 111-year history of the Federal Reserve. Recently, Greg Ip, chief economic commentator and senior central bank reporter for The Wall Street Journal, wrote that Trump's actions may mark the end of the independence enjoyed by the Federal Reserve since 1951, and the financial markets have not truly digested this significant risk.

The article states that regardless of whether Trump's intentions are ultimately realized, this event could become one of the most critical turning points for financial markets in decades. If the White House ultimately gains control over monetary policy, the U.S. may enter an era of higher inflation and greater volatility.

Investment bank Evercore ISI warned in a report to clients on Tuesday:

“The pricing in asset markets does not appropriately reflect the potential rupture of the Federal Reserve's independence.”

Greg explained that the current calm in the markets is partly due to Powell's dovish hints, which have boosted the stock market in the short term. However, more importantly, investors lack a historical reference for a politicized Federal Reserve, leading them to mistakenly assume that future central bank officials will continue to act based on economic data as before.

The article emphasizes that a wiser assumption for investors is that starting sometime in the next nine months, the Federal Reserve's interest rate decisions will begin to follow Trump's preferences rather than economic fundamentals.

Gradual Control: Trump's "Boiling Frog" Strategy

Greg pointed out that Trump's strategy towards the Federal Reserve is akin to his tariff policy, employing a "boiling frog" approach, whereby sufficiently slow incremental actions create the illusion that no significant changes have occurred at the macro level.

In early April of this year, when he announced high tariffs, the market reacted violently, prompting him to retract some of the plans. However, he subsequently reinstated most of the tariffs, and the market took it in stride.

Now, a similar scenario is unfolding at the Federal Reserve.

Last month, when Trump hinted at possibly firing Powell, the market was in an uproar. Therefore, he changed his strategy, no longer seeking to directly replace the chairman but instead aiming to achieve the same goal by placing his own people in positions.

Wall Street Insights previously analyzed that if he successfully replaces Cook, he will appoint four of the seven governors of the Federal Reserve. Trump also stated on Tuesday:

“We will soon have a majority. Once we have a majority, the real estate market will take off, and everything will be great.”

The governors appointed by Trump will not immediately control Federal Reserve decisions, as five of the twelve members of the Federal Open Market Committee (FOMC) are reserve bank presidents. However, the board has the authority to force some or all of the presidents to resign early next year The dismissal of a local Federal Reserve president would be an unprecedented break from tradition, but Trump has repeatedly indicated his willingness to do so.

Economist Peter Williams from investment research firm 22V pointed out in a report to clients that this is more like a "tail risk rather than a baseline scenario," but it "could have the greatest impact on policy as it may eliminate important dissenting voices within the FOMC, whether those voices are formal or verbal."

Behind the "for cause" dismissal is a loyalty test

In theory, once confirmed, Federal Reserve governors can vote on interest rates at their discretion.

However, Greg pointed out that by seeking to dismiss Cook for "specific reasons," Trump sent a clear signal: he could take the same action against any sitting governor who does not vote according to his wishes.

In seeking to dismiss Cook, Trump cited serious allegations of mortgage fraud, but Cook had not even had the opportunity to respond to these allegations before he requested her resignation last Wednesday. On Monday, Trump announced her dismissal, even though she had not been charged, let alone convicted. Cook stated that Trump had no authority to dismiss her and would take the matter to court.

The article emphasizes that if the court ultimately rules that the president has the authority to define "specific reasons," then the protections enjoyed by Federal Reserve governors, as stated by the Supreme Court, would be rendered meaningless. Even if Trump loses this time, he may try again, and his next target may choose to change their voting stance or resign rather than fight back.

Meanwhile, compared to his first term, Trump is now investing more effort to ensure the loyalty of his nominees. Typically, Federal Reserve governor candidates do not preview their decision-making tendencies before taking office, but this tradition has now been broken.

Trump's candidates generally express that, despite inflation remaining around 3%, above the Federal Reserve's 2% target, they believe interest rates should decrease.

For example, Stephen Miran, chairman of Trump's Council of Economic Advisers and a candidate for the Federal Reserve Board, believed last September that it was wrong to cut rates when core inflation was between 2.5% and 3%, but now echoes Trump's rhetoric, criticizing the Federal Reserve for its slow rate cuts.

Another candidate, former World Bank president David Malpass, wrote in The Wall Street Journal last week that the Federal Reserve should cut rates and defend the dollar with "forward-looking, market-based data" as a benchmark—despite the dollar's continued decline this year, which, according to his logic, is usually a reason against cutting rates.

Preparing for "structural changes in inflation"

The article states that in the short term, inflation will be determined by economic conditions rather than the Federal Reserve.

Currently, the U.S. inflation-protected securities (TIPS) market indicates that due to tariffs, inflation will experience a brief rise in the coming year, before returning close to the Federal Reserve's target level.

However, the market is not good at pricing structural changes in the economy. It failed to foresee the high inflation of the 1970s, the collapse of inflation under then-Federal Reserve Chairman Volcker in the 1980s, the real estate and mortgage crisis of 2007-09, and the inflation during the pandemic in 2021-22 Greg believes that betting on such rare events could lead to significant losses for investors. Nevertheless, investors may also need to start preparing for the upcoming structural shift in inflation.

The article cites that Williams from 22V listed the major macroeconomic policies currently at play, including the highest tariffs since the Great Depression, stimulative fiscal policies, a stagnant labor force, and ongoing attacks on the independence of the Federal Reserve. He concluded:

"This seems to be an environment that is just right for fostering super-target inflation."