Trump and Powell's war of words: Can the Fed find a "miracle cure" this time?

Recently, the conflict between "King of Understanding" President Trump and Federal Reserve Chairman Powell has escalated once again. Trump publicly declared on social media that it would be better for Powell to leave sooner, accusing him of being "late and wrong" in cutting interest rates, and demanding that the Fed follow the loose policy of the ECB. Powell responded firmly, stating that independence is a legal issue and that he will not bow to political pressure. This escalating war of words reflects the intense collision between the "America First" policy anxiety and the century-old reputation of central bank independence, as well as the deep-seated conflict between political pragmatism and long-term economicism. 1. Pressure and disagreements between Trump and Powell: Misalignment between tariff inflation and interest rate control The core conflict between Trump and Powell stems from the misalignment between policy goals and economic reality. Trump is seeking to offset the economic pain caused by the trade war with rate cuts, while also easing the interest burden of the $36 trillion debt to avoid the risk of US fiscal bankruptcy. Powell, on the other hand, insists on prioritizing inflation to avoid a painful memory from history - stagflation, and to maintain the dominance of the US dollar. Trump has deployed the major strategy of "equal tariffs" to reshape the US trade landscape and promote the reshoring of manufacturing, while also pressuring countries worldwide to pay taxes, reaping a windfall. However, the policy's side effects are significant - rising import costs leading to higher prices, exacerbating inflation pressures, and disruptions in the supply chain resulting from the trade war causing "supply shocks," weakening economic growth momentum and leading to a rare scenario of stocks, bonds, and the dollar all falling on Wall Street. To mitigate the short-term impact of the trade war on the economy and financial markets, Trump is urgently demanding the Fed to quickly cut rates to stimulate demand and reduce debt financing costs. After all, with the current US debt reaching $36 trillion, there is an imminent need for borrowing $6 trillion in new government bonds in June, and a 1% increase in interest rates will add $360 billion in interest payments, equivalent to half of the US's annual military spending. Powell's dilemma is that if a rate cut stimulates demand, it will inevitably further increase inflation, with former New York Fed President Dudley warning that inflation may approach 5% in the next six months. Maintaining high interest rates, on the other hand, makes it difficult for Trump to accept the economic recession triggered by the trade war and the plunge of US assets. What's even more crucial is that Trump's tariff policy has disrupted the dollar's "automatic stabilizer" function - a stronger dollar can suppress inflation, but as the world begins to shift towards a strategy of selling US assets, the de-dollarization trend will devaluate the dollar, becoming an amplifier of input inflation - stagflation will quickly become the Fed's "nightmare." 2. Feasibility of Trump replacing Powell - the struggle between legal obstacles and political risks Trump has repeatedly threatened to fire Powell, but in practice, it is more of a pressure tactic, as there are multiple legal obstacles. Firstly, Powell is protected by the Federal Reserve Act, with the Fed Chair only able to be removed for "just cause" (such as misconduct or criminal behavior), policy disagreements do not constitute legal grounds for dismissal. The 1935 Supreme Court case "Humphrey's Executor v. United States" clearly limits the President's power to dismiss heads of independent agencies. Secondly, the market and political costs are too high to bear. If Trump were to act forcefully, it could trigger a financial crisis in the US and shake the foundation of the dollar's dominance, facing legal challenges. Powell is resolute and would resort to legal proceedings, which may ultimately require a Supreme Court ruling. Although Trump is trying to challenge legal precedents through the Department of Justice, such as overturning the "Humphrey's case" principle, this process is time-consuming and has a low success rate. White House officials recently stated that firing Powell was only being considered, and it is more likely to pressure him through public opinion to make concessions. While Presidents publicly criticizing Fed chairs are not uncommon, such as the feud between Nixon and Burns, directly firing them and breaking a century-old tradition, risking the credibility of the dollar, would be unbearable. 3. The Fed's "magical potion" - historical lessons and a resolution to the current dilemma Historically, the Fed has successfully handled three major crises: (1) the Great Depression of the 1930s, establishing the central bank's role as the lender of last resort; (2) stagflation in the 1970s and 1980s, with Volcker's tough stance on raising interest rates to control inflation; (3) the subprime crisis of 2008, with Bernanke implementing quantitative easing (QE). However, the current situation is more complex, challenging, and with tariff policies leading to supply-side inflation, high debt, and political intervention, forming a "stagflation tail risk." If the Fed continues to cut rates as it did in September 2024, by 50 basis points, competing with the ECB in rate cuts, the inevitable outcome would be anchoring inflation expectations. Of course, persisting with a hawkish stance would bring the responsibility of an economic downturn. Can Powell, known for his flexibility, find a win-win solution this time? We believe that Powell is likely to be more flexible in his actions than his words, with possible policy options including structural policy coordination, quantitative easing tools, and strengthening data-based narratives to buy time for policy adjustments. Finally, this war of words between Trump and Powell is not just about the rate cut but a battle for the survival of the Fed's independence and the reliability of the dollar. If political intervention becomes normalized, the foundation of the dollar's dominance will be shaken, accelerating the global de-dollarization process. For Powell, the options of life and death are before him - will he be the scapegoat for Trump's trade war or defend the Fed's century-old reputation as Don Quixote? Or can Powell once again find a "magical potion" to make the Fed "great again"? This article is reprinted from the "Hai Qing FICC Channel" WeChat public account, Author: Deng Haiqing; GMTEight Editor: Song Zhiying.