By Howard Schneider
WASHINGTON (Reuters) -Global central bankers who have come to view the U.S. Federal Reserve as a source of stability now face an unpredictable period where the Fed’s monetary policy decisions are being pulled in conflicting directions and the institution’s independence could be at risk.
The Fed’s upcoming policy choices pose one issue, with the potential that as other central banks cut rates in response to slowing growth the U.S. needs tight monetary policy to ward off tariff-driven inflation, a divergence that could stress dollar funding markets and make financing more expensive for less-developed countries in particular.
Another, and perhaps more fundamental issue, is the question of whether the Fed can remain above the political fray in the face of attacks by U.S. President Donald Trump, who has repeatedly expressed his displeasure with the Fed’s policy and its chief, Jerome Powell.
A loss of Fed independence would undercut an institution that since the 1980s has become a sort of global public good helping anchor moderate inflation and modest interest rates, and ensuring cash kept flowing through the global economy during the 2007-to-2009 financial crisis and the pandemic.
At meetings here this week of the World Bank and International Monetary Fund, officials already preoccupied with Trump’s efforts to rewrite the global trading system and the expected jolt to growth as a result, were also hoping that a key lesson of the post-World War II order isn’t also lost.
“What is really important here is to make sure that central banks are able to do what is needed to anchor inflation expectations and that requires that everyone understands and trusts that they will respond,” IMF chief economist Pierre-Olivier Gourinchas said in an interview with Reuters. “Credibility of central banks is absolutely essential, and central bank independence is a key component for that.”
Independent central banks are considered better at managing inflation because they can impose high interest rates and tough credit conditions even if that slows growth, raises unemployment and undercuts elected officials’ popularity.
In remarks last week when asked about a possible loss of Fed independence, European Central Bank President Christine Lagarde said that the working relationship between the Fed and the ECB, which together oversee about 40% of the global economy, was “decisive in order to have a solid financial infrastructure.”
“We have demonstrated in the past that we could actually operate on that basis of consultation and understanding of the financial risk, and we will continue doing so in an undeterred and unchanged manner, I’m sure.”
UNSETTLED MARKETS
It was approaching an ECB rate cut last week that Trump raised the possibility he might attempt to fire Powell because he was not lowering borrowing costs.
It is unclear if Trump could remove Powell absent a compelling reason unrelated to monetary policy, and on Tuesday night he pulled back and said he had “no intention” of trying to dismiss the Fed chief.
But the possibility has further unsettled markets already rattled by Trump’s tariff plans, and highlighted that even if Powell remains as chair until his term ends in May 2026, there will be a transition when the president chooses a successor.
“We’ve had a really decent run of people at the head of the Fed kind of captured by the gravity of the office,” said Columbia Threadneedle senior rates analyst Ed Al-Hussainy. “The best bet is that the next person will follow the same course…But obviously this is now a more intense game and the outcomes could be more extreme.”
“How can we not be suspicious of whoever is appointed to that role in 2026?” wrote TSLombard global macro analyst Dario Perkins. “Trump clearly wants to set monetary policy by proxy. History celebrates the central bankers that stand up to political pressure, not the ones that cave. Anyone who understands that would surely have huge reservations.”
Powell says he feels the Fed’s independence is assured under U.S. law and has wide bipartisan support in Congress “where it really matters.” The Senate confirms a president’s Fed appointees.
Key programs like collateralized dollar loans to other central banks would keep operating, Powell said, because it benefits the U.S. to ensure markets for dollar-backed assets keep functioning.
Much of the Fed’s attention to global economic and financial issues is based on similar grounds. While Fed policymakers say their decisions are rooted in domestic economic conditions, the potential spillovers from international markets back to U.S. growth, employment and inflation are part of that analysis.
Trump, by contrast, seems to want to build distance between the U.S. economy and the rest of the world, a fact that could influence his choice of Powell’s successor and may already be reshaping world financial markets.
As Trump’s tariff plans unfolded, the simultaneous decline in the dollar and U.S. stock markets and a jump in U.S. Treasury yields at least hinted the country’s safe haven status may have taken a hit.
In a recent analysis, economists with the Institute of International Finance said they now see a “small recession” in the U.S. later this year largely driven by administration policies.
“In the case of the United States, the line separating cyclical weakness from deliberate policy engineering has grown increasingly blurred,” wrote Marcello Estevao, IIF managing director and chief economist, and senior economist Jonathan Fortun. “Rather than experiencing a traditional external shock…the United States now faces a more manufactured deceleration.”
The Fed, meanwhile, may be hamstrung by inflation that rises even as the economy slows, requiring a tricky assessment about whether those price pressures will fade on their own.
In comments last week IMF Managing Director Kristalina Georgieva said that after recent years where central banks aligned to support the global economy through the pandemic and later to curb inflation, policy may be at a crossroads.
“We are in a place where it is not going to be the same thing for everybody,” she said, with some countries overwhelmed by slowing growth and others where “fewer goods, more expensive goods…may push inflation up.”
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)
