The investigation of the Fed Chairman is likened to ‘playing with fire’

In a strongly worded statement on January 11, US Federal Reserve Chairman Jerome Powell confirmed that federal prosecutors have opened a criminal investigation against him, related to a building renovation project.

Commenting on the case, Karl Schamotta, chief market strategist at Copay (Toronto), warned of “unintended consequences” when putting pressure on the Fed. “Spilling gasoline everywhere and playing with matches usually doesn’t have a good outcome,” he said.

For investors, confidence in US institutions like the Fed is part of the so-called “excessive privilege” that the country enjoys in financial markets. That is the role of issuing the global reserve currency, the destination of hundreds of billions of dollars in capital flows.

Therefore, Mr. Karl believes that the government’s attempt to influence Fed officials with legal threats could erode the safe haven role of the USD. At the same time, this action also pushed up inflation expectations, triggering a sharp increase in long-term bond yields, thereby increasing borrowing costs across the entire US economy.

Previously, Mr. Powell frankly said that the criminal investigation was just an excuse to pressure the Fed to lower interest rates faster. On the channel NBCUS President Donald Trump said he knew nothing about the Department of Justice’s moves, but continued to increase criticism of the head of the central bank.

Damien Boey, Investment Manager at Wilson Asset Management (Sydney), pointed out that Fed Chairman Powell abandoned his silent approach whenever threatened by Mr. Trump. “This time, he chose to directly mention that the Fed did not adjust interest rates according to the President’s wishes,” he analyzed.

According to observers, the investigation and Mr. Powell’s unexpected reaction have sharply escalated the war of words surrounding the independence of the Fed, which is the foundation of economic policy and the pillar of the US financial system.

The ability of central banks to operate free of political interference – at least in determining interest rates – is considered a core principle of modern economics. This is to help monetary policy makers make decisions for the long-term stability of the economy.

On the morning of January 12, in Asia, the USD decreased slightly compared to major currencies. Gold prices climbed and US stock futures went down. Sentiment that the Fed will lower interest rates increased. “These developments are generally consistent with the ‘scenario’ where the Fed’s independence is attacked,” said Damien Boey at Wilson Asset Management.

Markets have fluctuated only slightly, but some investors are starting to wonder whether their portfolios are over-allocated to the US, given the new types of risks the Trump administration could bring.

“The market has ignored the ‘noise’ factors surrounding the Fed’s independence and will probably do it again. But at some point, everything will break down,” warned Christopher Hodge, chief US economist of investment bank Natixis (France).

Vishnu Varathan, Head of Macro Research for Asia (excluding Japan) of Mizuho in Singapore, said that smoldering doubts about the Fed’s level of independence have now been planted in investors’ minds.

“I’m not sure how sustained and confrontational the attacks on the Fed will be. But the question of Fed independence has now really heated up,” he said.

This strong counterattack by Mr. Powell is considered by observers to be a “parting shot” because his term as Chairman will end in May. Andrew Lilley, chief interest rate strategist at Australian investment bank Barrenjoey, predicts that in the immediate future the Fed will continue to maintain its own view on interest rates.

“Administrative interest rates will remain at the level desired by the majority of the Federal Open Market Committee (FOMC),” he said.

He also said that the legal battle against Mr. Powell shows that the Trump administration no longer has any leverage to pressure the Fed. Previously, the President announced that the next Fed Chairman would be “a person who believes in aggressively lowering interest rates.”

Mr. Richard Yetsenga, Chief Economist of ANZ, predicted that the activities of all three policy “arms” of the Fed will fluctuate a lot, including: interest rates, balance sheets and regulations of the banking sector.

“It’s too early to draw conclusions but the trend is quite clear. The technocracy of the Fed as we have seen over the past few decades is gradually fading,” he said.