The Next Battle: Trump vs. the Fed

The Liberation Day announcement of broad-based tariffs has triggered an unprecedented economic confrontation for the US - with both allies and trading competitors. But a potentially more significant battle may be brewing at home—not just with Democrats, but with the Federal Reserve.

What’s at risk isn’t just a spat between the President and the Fed Chair. Fed independence—long seen as a cornerstone of financial and price stability—could come under pressure, with far-reaching consequences for US markets.

A looming policy dilemma for the Fed

Even before the election, concerns were growing about what Trump 2.0 might mean for the Fed. The worry stemmed from Trump’s first term when he frequently criticised the central bank for not cutting rates. In 2019, Trump tweeted: “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi”.

In the aftermath of the Liberation Day equity sell-off, it hasn’t taken long for the President to turn his attention back to the Fed. In a tweet, he argued that falling oil prices justified a rate cut. This week Trump ratcheted up the pressure another notch saying Powell’s termination “cannot come quick enough”.

But even with the announcement of a 90-day pause on reciprocal tariffs, the outstanding tariffs still put the Fed in a bind. They’re likely to weaken growth while pushing up inflation—challenging both sides of the Fed’s dual mandate of maximum employment and price stability.

For now, the US labour market remains solid, with unemployment stable at 4.2%, giving the Fed room to focus on inflation. Indeed, in his comments following the tariffs, Chair Powell has struck a hawkish tone, noting that the larger-than-expected measures would likely worsen inflation.

Meanwhile, markets are still pricing in around a 0.75% cut in rates this year—betting that the Fed will respond once growth weakens materially.

But even if the pause on reciprocal tariffs helps the US avoid recession, it could set the stage for moderately weak growth combined with higher inflation—a mix that might see the Fed stay on hold, further straining relations with the White House.

Making sense of Trump’s trade policy

In the wake of the tariff announcement, investors and commentators have scrambled to rationalise the move. Many were shocked at the scale, believing that moderate voices like Treasury Secretary Scott Bessent may have persuaded the President to take a softer line.

An alternative explanation is that the announcement should not have come as a surprise. After all, Trump had threatened tariffs of 60% on China during the presidential campaign. The President should be taken literally, the logic goes.

If so, the implications for Fed independence could be stark.

Trump has previously expressed a view that he should have a say in monetary policy. He also said he wouldn’t immediately fire Powell, “as long as he was doing a good job”—a clear signal that might change if policy is not to his liking. He has also been open to the idea of naming a shadow Fed Chair - a move that would directly undermine the central bank.

While it’s not clear whether Trump has the authority to remove Powell, he seems likely to nominate a more administration-friendly pick when Powell’s term ends next year.

Central bank independence under fire

We’ve come to see central bank independence as normal—critical for maintaining price stability and preventing political interference in monetary decisions.

But it hasn’t always been that way. The push for independent central banks only really gained momentum in the 1980s and 1990s, following the inflation surge of the 1970s. For example, in the UK, the Chancellor still set interest rates as late as the mid-1990s.

Before that, Arthur Burns—Fed Chair for much of the 1970s—was widely seen as having bowed to pressure from President Nixon for looser policy. At the end of his term, Burns lamented that the Fed lacked the political backing for low inflation. Paul Volcker’s success in bringing down inflation in the early 1980s depended heavily on support from Reagan, in the face of congressional pushback.

The concern now is that a weakened Fed

(1) may be more inclined to keep policy easy to stimulate growth at the expense of higher inflation;

(2) could face political pressure in its supervision of the banking and financial system; and

(3) might be called upon to use its balance sheet to buy Treasuries should US debt levels spiral.

Up until recently, the idea that policymakers might meddle with central bank independence has seemed fanciful. During and after the Global Financial Crisis, central bankers were treated almost like rock stars—credited with staving off disaster while politicians clung to austerity. Monetary policy was “the only game in town”.

But we’re now in uncharted territory. The old rules of economic policy no longer seem to apply, and everything is up for grabs. If the impact of the tariffs proves to be as negative as most mainstream economists expect, the tension between the administration and the Fed looks set to ratchet even higher.