How much do investors really care about Fed independence?

The answer for some is more nuanced than you might think

Key points Summary Q&A

• Former Treasury secretary Janet Yellen has labelled US president Donald Trump’s attempt to remove Fed governor Lisa Cook as “profoundly dangerous” and a threat to Fed independence.
• Markets, though, have shown little reaction.
• Some analysts suggest that central bank independence is becoming a more complex issue, with calls for greater co-ordination between governments and central banks amid rising debts.

These summaries are generated by an LLM, but edited by humans.

“Profoundly dangerous” is how former Federal Reserve chair and US Treasury secretary Janet Yellen described president Trump’s attempt to remove Fed governor Lisa Cook from her post, writing in an opinion piece for the Financial Times on Wednesday.

The action constitutes a “direct attempt to politicise the Fed, intimidate its leadership and bend monetary policy to the president’s will”, Yellen states. “This action threatens to end the independence of the Federal Reserve – and with it, the credibility of the US’s monetary policy both at home and abroad.”

Markets have failed to register anything like the same drama. On Tuesday, thirty-year US Treasury yields, which largely reflect assumptions about long-term inflation, nudged higher by three basis points. Ten-year yields tightened. The S&P 500 closed 0.41% higher. The dollar sold off by about a quarter of a per cent.

Yellen herself seemed to acknowledge the apathy, exhorting the financial community to “raise its voice against a direct assault on the credibility of the dollar itself”.

The Federal Reserve has indicated that Cook’s status remains unchanged unless a court ruling says otherwise. And perhaps investors are confident that the governor will remain in place and the episode will serve to undergird, not undermine, the principle of Fed independence. The law states that a governor can only be fired for cause.

Let’s look at how many bonds every central bank owns, and you tell me which is the most manipulated market

Manish Kabra, Societe Generale

But could something else also be at play? The freedom of the US’s central bank from executive interference is often taken as a core tenet in US markets. But the non-response to Trump’s toeing of the line on the matter prompts the question: do market participants really care about central bank independence?

Some, it seems, view this supposed tenet of free and fair markets in fuzzier terms than often assumed.

Central bank independence is far from black and white, Manish Kabra, Societe Generale’s macro strategist tells Risk.net. Take the Bank of Japan. If the Japanese yen traded at ‘fair value’, it would be at levels at least 35% or 40% higher, Kabra reckons. The BoJ has adopted only a gradual rate-hiking cycle despite wage inflation and strong employment numbers. The cautious approach cushions the effect of rising interest costs on the country’s debt.

Multiple academics have written about how the expansion of central bank balance sheets during the era of QE may have caused a de facto erosion of independence. “Let’s look at how many bonds every central bank owns, and you tell me which is the most manipulated market,” Kabra says.

It’s a perspective that – even with potential meddling – places the US Federal Reserve at the more autonomous end of a spectrum of central bank freedom.

Others, too, dismiss the rhetoric of central banking ‘church and state’ as empty. Krishna Kumar, chief investment officer at Goose Hollow Capital, a macro hedge fund, says the concept of independence is “for the birds”. Even the idea is relatively new, he points out. Among the world’s main central banks, only the ECB was created as truly independent by formulation. The Bank of England received its freedom from Treasury control as recently as 1997.

Instances of co-ordination between governments and central banks have been commonplace, Kumar says, pointing to the Federal Reserve’s decision to run down its balance sheet more slowly in recent years as one example.

Others make the case that central bankers are political animals too. “People’s loyalties lie in certain places. They are human beings,” says Tim Magnusson, chief investment officer of Garda Capital Markets. The Fed’s reluctance to be pushed around by the president has clouded its decision-making about the timing of rate cuts, he believes.

“They don’t like being bullied. They don’t like being told what to do. And they’ll go as far as being unable to see the mistakes they’re making because they’re blinded by the idea they need to be treated better from a political perspective.”

Greater co-ordination

Are common assumptions changing? Kumar reckons co-ordination between an administration and its central bank might be necessary – indeed helpful for governments – and, perhaps, inevitable during a time when developed-world nations are sunk in debt.

“You can’t have the government saying it’s going to issue 20-year and 30-year bonds and the Fed saying it’s going to run down its balance sheet. That will blow the bond market up,” Kumar says. “There has to be more co-ordination, which means central banks won’t have the independence they used to.”

He is describing the kind of “financial repression” that investors told Risk.net they feared when we canvassed them about top risks at the start of the year.

The Federal Reserve held interest rates down during and immediately after World War II to assist in funding the war effort. Perhaps ironically, that led to tensions with Treasury and ultimately to the reassertion of central bank independence with the so-called 1951 Treasury-Federal Reserve Accord.

A bond-market buyers’ strike may yet happen. Most investors say a move by the US administration to fire Jerome Powell as Fed chair would lead to a big gap higher in US borrowing costs and a big gap lower in the dollar. But most also consider such a move highly unlikely.

Short of such an episode, Trump’s efforts to extend his influence over the Fed may yet continue to meet with a collective shrug.

Editing by Kris Devasabai