Powell is the leader of the free world – for now

NEW YORK, March 28 (Reuters Breakingviews) – As of early February, Joe Biden had never called Jerome Powell. But the US president’s bid to win a second term next year rests in part on how the Federal Reserve Chairman is handling high inflation and a banking crisis. As ex-President Donald Trump will confirm, Powell will do as he sees fit. But that may not stop Biden from wishing he could push the Fed to do what makes political sense, especially given the economic predicament Powell is in.

By March 10, Powell’s priorities were perfectly clear. After being slow to respond to a surge in inflation in 2021, the Fed has now laser-focused on curbing runaway consumer prices. Powell had authorized a rapid and aggressive series of rate hikes to cool economic activity – a plan he admitted “would cause some pain to households and businesses.”

As recently as March 7, Powell hinted that he could raise rates even faster than previously thought. In testimony in Congress, he hinted that the Fed’s interest rate could rise by 50 basis points later this month, surprising investors who had been betting on a hike half that size.

Three days later, a run on deposits at Silicon Valley Bank, the 16th largest lender in the United States, failed. The Fed and other agencies had to step in with a lending facility to increase liquidity for other banks and secure any deposit above the federally mandated $250,000 level. Shortly thereafter, the government shut down Signature Bank (SBNY.O) and persuaded major lenders to put deposits into First Republic Bank (FRC.N).

These banking crises derailed Powell’s anti-inflation plan, adding another front to his war on the US economic crisis – ensuring financial stability. That’s part of the Fed’s mandate, as is keeping inflation low and employment high, but the central bank doesn’t have to do much when banks are healthy. The failure of the SVB changed that.

The problem for Powell, the Fed, and Biden, who face a presidential election in November 2024, is that the roles of the central bank are at odds with one another.

Supporting the banks with liquidity injections increases the money supply and drives up inflation. This, in turn, dilutes the impact of the Fed’s drive to raise borrowing costs. However, recent shocks are likely to have prompted banks to cut lending, adding to the chilling effects of monetary policy and raising the risk of the US sliding into recession this year. To complicate matters further, the SVB failed because the sharp rise in interest rates caused losses on its bond portfolios, underscoring the risk that further tightening could cause more banks to fail.

At the center of this three-dimensional puzzle is Jerome Powell, a 70-year-old former attorney and partner at Carlyle (CG.O), the private equity group. Circumstances have given him enormous powers to influence the course of the world’s largest economy and the next presidential election, but also responsibility. His first move since the recent turmoil was a fudge – the Fed was targeting a quarter-point hike and said it was ready to support the banking sector.

History shows that economic conditions play an important role in how Americans vote. Bill Clinton’s campaign strategist James Carville famously coined the phrase “It’s the economy, stupid” as he charted the direction of his career. Franklin D. Roosevelt championed the idea that Americans should get a “New Deal,” which laid the groundwork for his program to revitalize the economy. President Gerald Ford took office in 1974 but was defeated in the next election after a Fed policy of raising interest rates to control inflation led to increased unemployment. Jimmy Carter similarly served just a single term after his spending plans to boost economic activity led to runaway inflation.

High unemployment is not an issue today, but that may not matter in the voting booths next year. Research by Gerald Kramer in 1971, analyzing voting patterns dating back to 1896, found that economic growth, as measured by changes in real per capita income, was the most important economic variable in the vote, while unemployment and inflation were little had influence. A 1992 study by three political scientists entitled “Peasants or Bankers” found that voters tended to “react with little gratitude for past prosperity regardless of future economic prospects.”

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Biden’s Democratic Party is well aware of this, and pressure is mounting on Powell, albeit from those who have always been reluctant to support him. This month, Democratic Sen. Elizabeth Warren, a leftist arsonist, went on TV and called Powell a “dangerous man” and said she doesn’t think he should be Fed chair. CNN TV host Jake Tapper asked her if she told Biden that Powell should be fired. Though Warren said she wouldn’t discuss private conversations, she reiterated that she thought he was doing a “really terrible job.”

Just last week, Biden reiterated his confidence in Powell. “President Biden has repeatedly shown – in word and deed – that he will ‘respect the Fed and will respect the independence of the Fed.’ An independent Fed is key to the president’s top economic priority: fighting inflation,” a White House spokesman said in a statement. But past presidents from Bill Clinton to George Bush to Donald Trump have publicly called for the Fed to make policy changes.

In practice, it is extremely difficult for a president to fire the chairman of an independent agency like the Fed — and this has never happened before. However, the next few months could test the relationship between Biden and Powell.

The problem for both the Fed Chair and the President is that inflation is not going away. The consumer price index rose 6% in February from a year earlier. That was down from 6.4% in January and marked the eighth straight monthly decline in the main price gauge. Still, inflation remains three times above the 2% target that Powell is aiming for — an uncomfortable level that requires further rate hikes. The Fed’s own expectations are for at least one more quarter-point hike, which will take rates to a range of 5% to 5.25%.

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That could pose problems for both banks and Biden’s re-election campaign, especially if the cumulative impact of Powell’s tightening campaign pushes the economy into recession. The Conference Board, a think tank, puts the probability of an economic contraction at 99% over the next 12 months.

Powell has been here before, with Biden’s predecessor. During his re-election campaign in late 2019, Donald Trump pressured the Fed to cut interest rates. Then Trump called Powell “a golfer who can’t putt, has no touch.” Trump wanted economic growth. Powell resisted, later responding that more than anyone else, the Fed chair must be free from political pressure.

Biden has a different style, and his predecessor’s opposition could make it doubly difficult to question Powell publicly. But if current banking and economic conditions force an abrupt change in the way Americans live, even Biden could find it increasingly difficult to bite his tongue.

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Editing by Francesco Guerrera and Sharon Lam

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