Trump’s Fed meddling pushes investors closer to their red line
There may be more stress than is apparent, particularly on long-term debt
WHERE is the line? When do financial markets tell Donald Trump that enough is enough with his efforts to meddle with the US Federal Reserve? We may be closer to that point than many think.
Academics, lawyers and former Fed officials are aghast at the president’s efforts to oust Lisa Cook, a governor at the world’s most important central bank. The comparison with Turkey is all too compelling – emerging-markets investors still swap horror stories about the period when its autocratic leader declared high interest rates to be the “mother of all evil”, sending inflation soaring and frying the country’s financial markets.
In the US, however, markets appear conspicuously relaxed. Far more focus has fallen on the latest earnings release from Nvidia than on this monetary manoeuvring. If you were ever in doubt about the benefits of operating the world’s biggest reserve currency, put those quibbles to bed now. No other country can get away with this stuff the way the US can.
The dollar has held pretty steady, stocks have risen throughout the week, and spotting signs of nerves in the bond market takes a trained eye. Once again, the message from markets to the president is: “Keep it up, sir! We like low interest rates anyway!”
So, we have conducted a natural experiment. We have seen how markets respond to an all-out assault on the institution that underpins American exceptionalism, and the answer is that they don’t seem bothered yet. What a time to be alive.
I’ve heard different interpretations from investors about what’s going on here. The optimistic school of thought is that this stuff just doesn’t matter, that the structure of the Fed will hold, or that Trump’s efforts to remould the central bank will fail. Efforts to unseat Cook are not exactly new – Trump has clearly had his beady eye on controlling the Fed for months, and interest rates are likely to fall soon, with or without this noise.
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On the margins, the US is helped by the seemingly annual French political drama, with the prospect of yet another government collapse. This has shoved up the country’s borrowing costs and undermined the argument that the euro and European markets are ready to fill the dollar’s role in global finance. Splendid timing from Team France.
Another interpretation is that if the bond market did really revolt, the Fed would be able to craft a response, such as a programme of long-term Treasury purchases.
A final view, though, is that markets are more stressed than they may appear. The rather subtle reaction in US government bonds over the past week or so is a steady strengthening in very short-term debt prices compared with very long-term paper. This is not easy to digest – not the source of scary stock market charts with a straight line pointing south. But it is already adding pressure to global bond markets, as the UK can attest.
It tells us that investors are increasingly sure that a US rate cut is coming, reasonably soon, but that inflation is likely to be a persistent concern further out, especially if a politicised central bank holds interest rates lower than it should to keep an interfering president sweet.
Long-term debt is precisely where any market rebellion will show its face. Again, a natural experiment is just around the corner. The US Treasury’s tentative schedule of upcoming debt auctions features only short-term debt in the coming week or so, and it appears Treasury secretary Scott Bessent has run a charm offensive to drum up demand for that kind of paper from stablecoin operators – a whole other risk hiding in plain sight. But longer-term debt will hit the markets in early September.
The key question is whether buyers will baulk. Recall that in April, it was a weak release of three-year US government debt on to markets that appeared to have spooked the Trump administration into backtracking on trade tariffs. Droopy demand then demonstrated that the usually reliable Japanese buyers stayed away. Chinese buyers stayed away. Suddenly, Trump backtracked, noting that bond markets had become “yippy”. He is probably aware of how important it is to keep overseas bond buyers on side to fund spending. His Treasury secretary certainly is.
For usually reliable bond buyers, staying away now is not without risks. Refusing to buy US government debt, or agreeing to buy only at a much lower price, could irk Trump. Already, governments are finding that pushing back in trade negotiations, for example, is not worth the bother. They fear retribution. The same may be true here – it turns out that bullies do prosper. But if there is serious pushback, this is where we will see it.
The sad reality is that market participants are growing accustomed to the drip, drip of institutional degradation. What would have been an outrage a year ago is par for the course now.
If investors allow this to pass unchecked, they should not be surprised if even more outlandish policies emerge further down the line. Capital controls, anyone? Without a market rebellion, it is hard to see how it all stops. Your move, bond vigilantes. FINANCIAL TIMES
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