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President Trump's efforts to gain more control over the Federal Reserve could bring about a sharp decline in the stock market.
The S&P 500 (SNPINDEX: ^GSPC) has advanced 10% year to date despite a dramatic shift in U.S. trade policy and the passage of a reconciliation bill that could add more than $4 trillion to national debt in the next decade, according to the Congressional Budget Office.
Those changes alone are cause for concern: Tariffs and deeper deficits could sink the stock market. But President Trump recently fired Federal Reserve Governor Lisa Cook, providing investors with yet another reason to worry. Here are the important details.
Image source: Official White House Photo.
The tariffs imposed by President Trump have increased the average tax on U.S. imports to 18.6%, the highest level since 1933, according to the Budget Lab at Yale. Anticipating the impact is difficult, but most economists expect tariffs to result in higher prices and slower gross domestic product (GDP) growth. In turn, corporate earnings could weaken and the stock market could drop, perhaps substantially so.
More recently, President Trump fired Bureau of Labor Statistics (BLS) Commissioner Erika McEntarfer after the agency announced dismal nonfarm payroll numbers for May, June, and July. He claimed without evidence the data was rigged as part of a politically motivated attack. The decision to fire McEntarfer without clear cause may undermine confidence in future economic data, according to the Economic Policy Institute.
Trump has also blurred the line between the public and private sectors unlike any president in recent history. After first banning Nvidia from selling H20 GPUs in China over concerns about national security, he later changed his mind in exchange for a 15% revenue-sharing arrangement. Trump also negotiated a deal with Intel whereby the U.S. government now owns a 10% stake in the company, giving the administration a clear incentive to play favorites in the semiconductor manufacturing industry.
President Trump desperately wants the Federal Reserve to lower its benchmark interest rate. Doing so would stimulate the economy and offset headwinds created by his trade war. But policymakers have so far held rates steady, a prudent decision given uncertainty about how tariffs will affect the economy. Trump has responded by threatening to fire Fed Chair Jerome Powell. "If I want him out, he'll be out of there real fast," he said earlier this year.
Trump has since walked back that threat to some extent, saying it's "highly unlikely" he will move to fire Powell. Nevertheless, the president has continued to lambast the Fed chair on social media, calling him a "numbskull" and a "stubborn moron" that is "too stupid" to do his job. More recently, Trump fired Fed Governor Lisa Cook, his most aggressive attempt to date to gain more control over monetary policy.
Here's what happened: Cook reportedly listed two properties, one in Michigan and another in Atlanta, as primary residences on mortgage applications submitted in 2021. Trump cited the conflicting paperwork as "sufficient cause" to remove her from the Federal Reserve's seven-person board, something no president has done before. Cook plans to file a lawsuit challenging the decision, but Trump would be able to appoint a new board member if the firing stands.
So what? If investors start to question the Federal Reserve's independence, they would also have reason to question whether monetary policy decisions are being made to promote the long-term strength of the U.S. economy (as they should be) or whether the goal is short-term political gain. In turn, bond investors would demand higher yields on Treasuries, which would make stocks less attractive by comparison.
JPMorgan Chase strategist David Kelly explains, "If the president prevailed in this fight, markets might well conclude that this marked the end of Fed independence, potentially triggering a plunge in the U.S. dollar, a surge in long-term interest rates, and a selloff in the stock market."
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