The Rise of the Fed: Can Trump Dismiss Powell?

If you've been in the markets for a while, you’ve probably felt the "Fed Shock" more than once.

This powerful central bank, the Federal Reserve, has global markets hanging on its every move.

When Powell approaches the podium, investors hold their breath for that "Good afternoon."

So how did the Federal Reserve get started and gradually gain its power? Let’s dive into this macro lesson and find out!

Despite its massive influence today, the Fed has been around for just over a century.

Back when the U.S. was founded, there was no central bank as we think of it today.

The U.S. faced several financial crises by the late 19th and early 20th centuries.

The panic of 1907 was a real doozy—think domino effect with a trust company’s collapse triggering a nationwide panic. Banks were failing left and right.

J.P. Morgan, the financial wizard, stepped in like a superhero, rallying a 'bankers' alliance' and injecting private funds to stabilize the market.

Today, two financial companies in the U.S. market are named after Morgan: JPMorgan Chase (JPM) and Morgan Stanley (MS).

Both trace their origins back to banks founded by J.P. Morgan.

These crises underscored the need for a central bank, leading to the Federal Reserve Act of 1913 and the birth of the Fed.

Initially, the Fed's power was relatively limited.

Compared to the earlier, more unstable years, it did help reduce financial volatility.

However, during the two World Wars, the Fed essentially became an extension of the Treasury Department.

It helped the government  raise war funds at lower costs, which contributed to wartime inflation.

The Fed’s response to the Great Depression of 1929 was lackluster. It largely stood by while the crisis worsened.

Post-World War II, an agreement was reached to restore the Fed’s independence from the Treasury, but true independence was still a work in progress.

By the 1970s, the economy showed signs of slowing down and inflation was on the rise.

President Nixon, seeking re-election, pressured the Fed to lower interest rates to stimulate the economy.

Nixon famously said, "I respect his (Fed Chair) independence. However, I hope that independently he will conclude that my views are the ones that should be followed."

This was almost a blatant threat, wasn't it?

While short-term rate cuts did help Nixon win re-election, they also unleashed the monster of "stagflation."

Stagnant growth, soaring unemployment, and rampant inflation tarnished the Fed's reputation.

In 1979, Paul Volcker became Fed Chairman amidst turmoil. He became a staunch defender of the Fed's independence, withstanding pressure from all sides, and implemented unprecedented monetary tightening policies.

To combat inflation, the Fed significantly raised policy rates, reaching nearly 20% at one point.

This initially made borrowing expensive, curbing spending and investment, and deepening economic woes. Critics were all over him, accusing him of driving the economy into a recession.

But Volcker stood firm, believing that taming inflation was key to getting out of the rut.

History vindicated him, as the U.S. economy got back on track in the '80s.

His bold moves restored the Fed’s credibility, and his commitment to central bank independence and transparency set a benchmark for future Fed chairs.

Janet Yellen, Fed Chair from 2014 to 2018, said Volcker "embodied the values we hold most dear: devotion to public service, the courage to do the right thing, even when it's immensely unpopular."

Following Volcker, the Fed's influence in global financial markets grew alongside the strengthening U.S. economy.

The Fed became more open about its decisions, using tools like forward guidance to better manage public expectations.

The Fed took decisive action during the 2008 financial crisis and the 2020 pandemic shock to stabilize the economy.

During Trump's first term, he often publicly criticized the Fed,    suggesting he could replace the Fed Chair.

But in reality, a president can’t directly fire the Fed Chair, only nominate a successor when the term ends. The Fed remains quite independent today.

Thanks for watching, and see you next time!