President Trump's long-standing mission to subdue the Federal Reserve has gained new momentum. With the departure of Governor Adriana Kugler, the president has an excellent opportunity to staff the central bank with a loyal supporter. However, as the shockwaves subside, some experts warn: stripping the Fed of its independence, though an unlikely scenario, creates an economy vulnerable to risks and debts, and in the worst case—a world where the dollar could permanently lose its safe-haven status.
"Stripping the Fed of its independence and setting monetary policy to maximize short-term economic growth will lead to a very troubling escalation of long-term debt imbalances. It will also increase the instability of the U.S. economy and financial system, provided that the initial positive effects on growth are not interrupted by a full-blown bond market revolt," MRB Partners noted in a recent memo.
A dangerous extension of the debt supercycle
The primary effect of a politicized Fed is likely to be felt in the bond market, as lower rates will encourage politicians to raise the Richter scale of debt higher to quench the thirst for faster economic growth.
But this likely 'substantial extension' of the U.S. debt supercycle is not a free lunch: 'Such a policy could create a sustained period of economic growth above potential, but at the cost of increasing long-term economic and financial instability in the market.'
The Treasury market is sharply shifting towards short-term debt
With an administration focused on maximizing short-term growth, Uncle Sam will sharply refocus on short-term Treasury bills, abandoning long-term Treasury bonds to reduce interest expenses. But this move will come with risks: servicing costs will be dangerously tied to short-term rates, making U.S. debt more volatile as the long end of the yield curve becomes less liquid, and the actual 'savings' on costs may be overstated, MRB noted.