Introduction to the Federal Reserve Controversy
The dismissal of Federal Reserve Governor Lisa Cook has raised concerns about the independence of the U.S. central bank. This comes at a time when the White House is pushing for lower interest rates, despite rising inflation. The impact on the market has been noticeable, with short-term bonds falling and long-term bonds rising in anticipation of a looser monetary policy.
The Imminent Legal Battle
Cook’s future will be decided in the courts, and the Federal Reserve will abide by judicial rulings. The turmoil has not significantly altered market expectations, with an 87% probability of the Fed cutting interest rates at its September meeting. If this happens, it would break with an unwritten rule of monetary policy: not lowering the cost of money in an environment of rising prices.
Historical Precedents
According to a Bank of America report, the last time the Fed cut rates amid rising inflation was in 2007, on the eve of the Great Financial Crisis. This decision prioritized early signs of weakness in housing and labor markets over rising global energy and food prices, ultimately contributing to the worst financial crisis in 80 years. Fast-forward to 2025, employment data has been disappointing, and Jerome Powell has suggested a policy shift after 10 months without rate cuts.
Inflation Concerns
U.S. inflation closed July at 2.7%, the same rate as June but higher than May’s 2.4% and April’s 2.3%. Core inflation, excluding food and energy, rose to 3.1%, its highest in six months. Although the Fed has a dual mandate of price stability and maximum employment, since 1973 only 16% of rate cuts have occurred while inflation was rising. Howard Du, a currency analyst at Bank of America, believes the consequences of cutting rates against rising inflation are clear: a weaker dollar and higher inflation in the long run.
Market Impact
The impact on the bond market is also significant, as a looser monetary policy could lead to higher inflation and lower bond prices. This, in turn, could mitigate the impact of rate cuts, as mortgage rates are tied to the 10-year Treasury yield. If the bond market anticipates higher inflation and the 10-year yield rises, rate cuts won’t translate into lower mortgage costs or cheaper business loans.
Central Bank Dilemmas
Other central banks, such as the Bank of England, face similar dilemmas. The Bank of England has been more aggressive in cutting rates, but has run into surprisingly negative inflation. This has led analysts to view another cut as increasingly unlikely. Powell, nearing the end of his term, will try to avoid making the same mistake and will likely aim to secure a favorable judgment from history rather than pleasing the president.
Conclusion
The controversy surrounding the Federal Reserve’s independence and the potential rate cut has significant implications for the market and the economy. As the Fed navigates this complex situation, it must balance its dual mandate of price stability and maximum employment while avoiding the mistakes of the past. The outcome will have far-reaching consequences, and only time will tell if the Fed will make the right decision.
