A worker at the construction site of the Federal Reserve headquarters, after U.S. President Donald Trump renewed his threat to bring a lawsuit against Federal Reserve Chair Jerome Powell over Mr. Powell's management of renovations of the building, in Washington, on Monday.Kevin Lamarque/Reuters
Former U.S. Federal Reserve leaders and some sitting Republican politicians lined up behind the beleaguered Fed Chair Jerome Powell on Monday, calling the Trump administration’s criminal investigation into the central bank’s leader an example of coercion reminiscent of an emerging market economy.
Financial markets largely shrugged off concerns about eroding Fed independence, while some economists and former central bankers warned against complacency and suggested that a loss of confidence in the Fed could bleed across the border into Canada and rattle global markets.
On Sunday evening, Mr. Powell released an extraordinary video explaining that the U.S. Department of Justice had served the central bank with subpoenas threatening a criminal indictment.
Fed Chair Jerome Powell issued a video statement in which he bluntly characterized the threat of criminal charges against him as simple 'pretexts' to undermine the Fed’s independence when it comes to setting interest rates.
The Associated Press
The inquiry centres on cost overruns on renovations of two Fed buildings in Washington, and Mr. Powell’s testimony to Congress about the project.
But Mr. Powell dismissed this as a pretext. U.S. President Donald Trump has spent months harrying him and his colleagues in an effort to exert more control over the independent central bank and push it to lower interest rates.
A statement published Monday and signed by 14 former central bankers and government officials, including every living former Fed chair – Alan Greenspan, Ben Bernanke and Janet Yellen – excoriated the Trump administration.
“The reported criminal inquiry into Federal Reserve Chair Jay Powell is an unprecedented attempt to use prosecutorial attacks to undermine that independence,” the statement said.
“This is how monetary policy is made in emerging markets with weak institutions, with highly negative consequences for inflation and the functioning of their economies more broadly.”
Trump administration threatens to indict Fed Chair Jerome Powell
Three sitting Republican senators – Thom Tillis, Lisa Murkowski and Kevin Cramer – also expressed concern about the administration’s move, suggesting that Mr. Trump may face opposition from his own party if he attempts to ram through a nominee to replace Mr. Powell, whose term as chair ends in May, or tries to stack the Fed board with cronies.
Ms. Murkowski, a senator from Alaska, said in an online statement that she spoke with Mr. Powell on Monday and viewed the criminal investigation as “nothing more than an attempt at coercion.”
The investigation is a significant escalation in Mr. Trump’s attempt to exert control over the Fed – the world’s most important central bank and the linchpin of global finance.
His administration has also launched a criminal investigation into Fed governor Lisa Cook, who sits on the 12-member Federal Open Market Committee that sets U.S. interest rates. Mr. Trump has placed close ally Stephen Miran on the Fed’s board of governors on an interim basis.
BoC’s Macklem says U.S. Fed Chair Powell has his ‘full support’
These apparent attempts to intimidate Fed officials and exert more control over monetary policy have raised concern among economists, who widely regard a central bank’s ability to set interest rates independent of political pressure as essential for maintaining low and stable inflation.
“History shows that central banks with operational independence are more successful at delivering price stability for their citizens,” Bank of Canada Governor Tiff Macklem said in a statement on Monday.
“I reiterate my full support for Federal Reserve Board Chair Jay Powell, who reflects the very best in public service. Chair Powell is doing a very good job under difficult circumstances, guiding the Fed to take monetary policy decisions based on evidence, not politics,” Mr. Macklem said.
Financial markets appeared largely unmoved on Monday by the drama unfolding in Washington. Gold jumped, as usually happens amid uncertainty, and the U.S. dollar weakened against other currencies. But stock markets rose and bond markets remained relatively stable, with long-term yields rising slightly.
“If you didn’t know about the announcement, you would think the market moves were just part of a normal daily volatility,” Beata Caranci, chief economist at Toronto-Dominion Bank, said in an interview.
Investors anxious over make-or-break fight for the Fed
There’s a rationale for this relative calm, she said. While there’s no doubt Mr. Trump will replace Mr. Powell with a more dovish chair amenable to his vision for lower interest rates, the chair is only one of 12 voting members on the committee that sets rates, and may have a hard time winning over other members to an inflationary policy.
Likewise, a more dovish Fed might be checked by financial markets, said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce. If investors begin to expect higher inflation, they’ll push up long-term bond yields, countering Mr. Trump’s desire for lower mortgage rates. (Central banks only control short-term interest rates; long-term rates are set in the bond market.)
“There is a possibility that the Fed gets a little bit too aggressive with rate cuts, led by a new chair who pushes it that way. But the bond market does have, in effect, a bit of a veto power,” Mr. Shenfeld said in an interview.
“Because if long-term interest rates start to climb on fear of inflation, it’s going to be a big stop sign in front of the Fed. No one’s going to vote for deep short-term rate cuts that are going to push mortgage rates higher.”
Former Bank of Canada deputy governor Tim Lane, however, said that it’s important not to get complacent about the erosion of Fed independence.
‘It is not good’: What the Street is saying as Trump-Fed feud escalates
The past two decades have several examples of central banks losing their independence to populist governments and pursuing reckless inflationary policies to finance government spending, most notably in Argentina and Turkey.
“I think there’s generally a perception that, ‘Well, this could never happen in the U.S.’ But there may come a time when that view becomes too sharply in conflict with the facts as they emerge, and at that point, you could see a pretty abrupt correction in the markets,” Mr. Lane said in an interview.
A Fed inclined toward lower interest rates could impact Canada in a number of ways, he said. The Canadian dollar would likely appreciate against the U.S. dollar, helping importers but hurting exporters. Long-term bond yields, which underpin mortgage interest rates, would likely rise in conjunction with higher U.S. bond yields.
The biggest risk, Mr. Lane said, is that investors lose faith in a politically compromised Fed, causing cracks in the global financial system.
“The U.S. dollar is really the anchor of the global financial system, and there’s a whole lot of expectations and conventions … that reinforce that. It can hold for a long time, that confidence. But if it’s lost, it can happen very suddenly and that could be a pretty major shock for Canada and for the world in general,” he said.