The Heat Is On at the Fed

Rate cuts are coming—but not for the reasons politicians hope. Here’s what Powell may really be watching.

 

 

KEY TAKEAWAYS

• The Fed’s headquarters may look quiet—but Powell is under intense political pressure
• Powell's famous 2019 "dovish pivot" helped markets recover from a near 20% crash
• Presidents have always tried to influence the Fed–Trump’s is a master class in aggressive jawboning
• Despite public threats, the President can't legally fire the Fed Chair
• The Fed remains on hold due to strong growth and sticky inflation

MY HOT TAKES

• The Fed building is boring—but the policy battles inside are anything but
• Trump’s jawboning is just louder—not new
• Powell’s real pivot trigger is the market—not the President
• The Fed’s structure protects it—one vote can’t change policy
• Rate cuts will come—but not for political reasons
• You can quote me: “The President is unrelenting with his public pressure on Powell—but even if he could fire him, the costs would outweigh the benefits.”

Door busting. We are right in the middle of the dog days of summer and it is hot in here! Spicy hot. 🔥🥵 Oh, it’s hot on the streets of New York City, for sure, but I am not referring to that. Nor am I referring to the oppressively hot and humid streets of Washington DC, but rather a small-ish, grey-ish building on the corner of 20th Street and Constitution Avenue NW. That would be the location of the Federal Reserve’s headquarters building.

 

The building is not impressive but for a massive eagle perched atop of its unassuming entrance. Built in 1937, the building, designed in what is called stripped classicism, is supposed to convey stability, authority, and, well, permanence. And, I suppose it does. I have walked past it many times and–all joking aside–it always looked empty. I mean, I know that it is full of nerdy economists clicking away in spreadsheets, but still it doesn’t exactly give off the same vibes as, say, possibly the second most important building in the world–the New York Stock Exchange (yeah, I am biased). At the end of a long hallway spiked with pictures of boring guys (and 1 gal) who ran the Bank since its establishment in 1913, sits current Chairman Jerome Powell’s office. If you have been following things lately, the air in that office is anything but light.

 

The Chairman is under massive pressure from politicians, namely President Trump who has literally had his foot on Powell’s throat since moments after his ‘24 election win. Never mind that Trump, himself, appointed Powell, sending his predecessor Janet Yellen packing. When Powell accepted the President’s offer back in 2018, he knew that he had his work cut out for him. The US economy was on the verge of setting a record for longest economic expansion. Many economists were predicting recession. The yield curve had been flattening since 2014 and was close to inverting as Powell set up the pictures on his desk at Fed HQ. Remember that a flattening yield curve is a result of a stalling economy, and an inverted yield curve, where short maturity yields exceed long ones, portends a recession… statistically, at least. It was more than that. 

 

Corporate earnings growth was stalling. However, from a myopic Fed perspective, things were kind-of steady as she goes. Steady because the Fed has only 2 (yes 2) primary objectives: strong labor market and stable inflation. Both were unarguably healthy. Powell’s job would be a cakewalk as long as he kept the ship on course. Before he could celebrate his first Fed holiday party, things got markedly worse as the economy showed further signs of decay. Equity markets gained ground in a tooth-and-nail grind but completely collapsed in the fourth quarter of the year resulting in a nearly -20% drawdown that bottomed on Christmas Eve! Talk about coal in your stocking. The media was dubbing it as the worst December since The Great Depression. As in the one with the capital “T” and capital “D”--that one. Of course, it didn’t help that the Fed was RAISING interest rates throughout the year with the latest hike just weeks before.

 

A few days later, Powell saved the day with his famous dovish pivot. A few months prior, the Chair said that the Fed was “a long way from neutral,” which in the context of the then-tightening Fed, meant more cuts. Not only did it freak out the market, but it got the attention of President Trump who called Powell “crazy.” The crazy would not last long, because only a few days later on January 4th, Jerome Powell said, “we’re listening carefully to the market… we’re prepared to adjust our policy stance as appropriate.” Yes, it was a full-dovish pivot. That pivot allowed markets to fully recover from 2018’s pullback. It wouldn’t be until the Fed’s July meeting that the first interest rate cut came, and was received with adoration by markets, which were losing steam. Powell called it a “mid-cycle adjustment.” He had to call it something, because, really, the Fed’s dual mandate objectives seemed to have nothing to do with the cuts. COVID would change all the variables, throwing the global economy into a state not experienced in modern economic history. Powell and his Fed would take aggressive action by mid-March sending Fed Funds to 0% and adding an unprecedented package of monetary stimulus. Many argue that it was the Fed action that turned the -34% market decline around. The S&P 500 would gain some 110% from its 2020 low through Powell’s second notable pivot in late 2021 in which he went from good guy to bad in a Congressional testimony where he warned of tighter policy to fight rapidly expanding supply-push inflation.

 

Happy Hour at the Fed was over. The Unhappy Hours saw the unprecedented interest rate hikes that dotted 2022 and 2023. Powell and his Fed–once benevolent–became the arch enemy of retirement accounts. That pain was a -25% drawdown to its lowpoint in late 2022. It wouldn’t be until March of 2023 that the markets became distracted with the arrival of AI, which has trumped all else, rightly so. 

 

Back at the Fed, policymakers were still fighting the massive, inflation dumpster fire which peaked a year earlier in the summer of ‘22 but was still far from the Fed’s 2% target. The Fed would keep the emergency brake pulled up to the max for over a year before releasing it by -50 basis points in September of last year. Two more 25 basis point cuts would follow before the easing would stop.

 

President Trump was elected and it was clear that tariffs and massive fiscal stimulus would follow. Both of those are considered inflationary. The Fed would use those to keep policy unchanged as the bankers went into a “wait and see mode.” That brings us to where we are today. Still waiting, but seeing… well, nothing… yet. The Fed funds rate today is 2.75% higher than it was before the pandemic. Though there is much debate around this, a consensus of economists would argue that the current rates are restrictive, that is, they are a drag on economic growth.

 

There are some practical challenges with rates at these levels as well. First, the entire Real Estate sector is completely frozen; it relies heavily on lower short-term rates. Many commercial real estate investments were made when rates were far lower. That is a much bigger story, which I will cover some other time. Second, higher yields make government borrowing more expensive. Fiscal stimulus costs money, and the administration is committed to minimizing the swelling deficit. For reference, interest expense from Government debt makes up around 14% of the budget deficit. That’s on par with Medicare and Defense. Cutting expenditures there is not so easy, but cutting interest expenses may be as simple as THE FED CUTTING RATES. That is one reason amongst many others that the President would like to see rates lower. Understandable, along with his belligerence toward Powell in an effort to get the Chair to lower rates.

 

Let’s be clear. All Presidents want rates to be lower. Truman and Johnson wanted lower rates to make funding the Korean and Vietnam wars cheaper. Nixon exclaimed “I want a goddamn money supply increase,” captured in his secret tapes. Reagan and Bush too pressured the Fed, both publicly and privately. That is referred to as jawboning, and it is completely legit. The Fed is independent, but there is nothing wrong with attempting to pressure the independent bankers to bend to public outcry by using the so-called bully pulpit. That makes President Trump no different than his predecessors. The President however has taken his jawboning to another level, threatening to fire the Chair, a move which is believed to be illegal. The President is unrelenting with his public pressure on Powell. Even if he could, would the President actually fire Powell? Probably not, because the implications on the nation's monetary system would be devastating. In other words, the costs would outweigh the benefits. As part of the President’s jawboning campaign, names for Powell’s successor have been floated with each candidate calling for lower rates now. Even if any of these candidates were to become chair, would anything change? NO! The Fed chair, though influential, gets only 1 vote on monetary policy. THERE ARE 11 OTHER VOTERS!

 

So, what is Powell going to do in response to the President’s pressure? Well, probably NOTHING. The economy is holding up nicely, employment is solid, and inflation is still above target and has ticked up, albeit marginally. So that’s it? No. There still is one thing. Looking back to Powell’s first year on the job, we may recall that there was one thing aside from employment and inflation that would soften his heart. Remember from above ☝️, “...listening to markets?” That’s right. With markets hovering just below all-time highs, we can assume that the President’s threats will continue to land on deaf ears. Those cuts will eventually come, but not at this point… if history is any guide.

 

FRIDAY’S MARKETS

Stocks closed marginally lower, getting little support from a better than expected sentiment report. Options expiration added to the day's volatile trade.

 

NEXT UP

• Leading Economic Index (June) is expected to have slipped by -0.3% after a -0.1% decline in the prior period.
• Later this week, some 100 S&P 500 companies will release Q2 earnings and we will get some housing numbers, PMIs, and durable goods orders. Though they are all important numbers, earnings will dominate trade this week. Download the attached calendars to be the sharpest tool in your shed.
• Important earnings today: Domino’s Pizza, Verizon, Roper Technologies, and Alexandria Real Estate Trust.

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