President-elect Trump is accustomed to criticizing the Federal Reserve. During his campaign, he stated that the Federal Reserve's interest rate decisions should seek his input, contrary to the tradition of the Federal Reserve maintaining its independence.
Federal Reserve Chairman Powell did not ignore these remarks; he explicitly stated that he would not resign if Trump asked him to, citing that the president has no legal power to remove him from office.
These dynamics foreshadow a confrontation between the Federal Reserve and the incoming president, and TS Lombard economist Dario Perkins believes Powell will have the upper hand.
In a report to clients on Monday, he pointed out that leaders including former UK Prime Minister Liz Truss and former Italian Prime Minister Silvio Berlusconi were forced to abandon overly loose fiscal policies because their respective central banks refused to bail them out, preventing them from escaping the turmoil in the bond market that led to spiraling interest rates.
In these situations, central banks collaborate with private 'bond vigilantes', who express dissatisfaction with unsustainable budget deficits through the market.
Trump proposed a series of populist policies during his campaign, including massive tax cuts, new tariffs, and large-scale deportations of undocumented immigrants. Economists believe these policies will drive up inflation, forcing the Federal Reserve to reverse its recent trend of interest rate cuts.
“Now we are facing a larger-scale confrontation between populists and 'bond vigilantes', many expect a conflict between Trump and Powell to erupt,” Perkins wrote. “If Trump challenges the Federal Reserve, it is conceivable that Powell may 'weaponize' the bond market to teach Trump a lesson.”
Perkins believes that if Trump attempts to influence interest rate decisions, Powell is likely to remain resolute, as he will almost certainly not be reappointed after his term ends in May 2026.
Perkins wrote that Powell might become the one to 'tame post-pandemic inflation' under the severe criticism of a profligate president.
The dollar's status as a reserve currency and the role of U.S. Treasury bonds in global financial markets mean that even in the confrontation between Trump and Powell, 'bond vigilantes' are unlikely to 'indiscriminately sell off U.S. assets' unless Trump can successfully persuade the Federal Reserve to lower interest rates in the face of rising inflation.
“Trump causing chaos at the Federal Reserve” would be a 'nightmare scenario' for the bond market, but Perkins does not believe this is the most likely outcome.
“The most likely conflict is simply Trump continuing his policies while Powell ends the rate-cutting cycle prematurely,” Perkins wrote. “After all, if problems arise between 2025-26, the blame will fall on Trump's chaos, not on the Federal Reserve keeping interest rates above some vague neutral level.”
The article is reposted from: Jin Ten Data