Your wealth and investments are on the line if Trump torpedoes the Fed's independence

By Felix Vezina-PoirierWhen politicians get involved with central-bank decisions, inflation, the dollar and the stock market all become less predictableFederal Reserve Chair Jerome Powell has become a symbol of central-bank independence.The Federal Reserve was served grand-jury subpoenas by the U.S. Justice Department that threaten a criminal indictment. While serious, it's unlikely that the Trump administration's effort to control the Fed will ultimately succeed. The move appears aimed at pressuring Fed Chair Jerome Powell to step down from his board seat once his term as chair ends in May, even though his separate term as a Fed governor runs until January 2028.Markets have reacted in a muted fashion so far - an indication that investors believe the administration's initiative will fail to gain momentum. The U.S. Senate, along with the bond market, represents a key institutional constraint.For investors, a meaningful erosion of central-bank independence would weaken the Fed's inflation-targeting discipline and be negative for both stocks and bonds, as markets have long operated under the assumption that Fed independence will hold. Such pressure also argues for rethinking strategic allocations to real assets, including commodities, inflation-linked bonds and real estate.Fed independence and inflationEconomic volatility and disruption are costly for households, businesses, governments and markets. A way policymakers seek to reduce that volatility is by stabilizing expectations, particularly inflation expectations. That objective is tightly linked to central-bank independence.An independent central bank raising interest rates when the economy overheats and lowering them when activity is depressed helps keep interest rates moderate over both the long run and across business cycles. Economic stability is enhanced when monetary policy, which aims to avoid extremes in the business cycle, is kept out of the hands of elected politicians.Absent that institutional framework, inflation is more likely to become persistent and volatile. The bond market would need to price that risk, pushing long-term inflation expectations above the central bank's target and lifting long-term interest rates. That, in turn, would raise borrowing costs for households and businesses, weighing on long-term economic growth.Central-bank independence and inflation targeting do not imply inflation always remains at target. Rather, they mean the central bank will act decisively to bring inflation back to target when deviations occur.While higher interest rates are unpopular, the real trade-off is between having them temporarily when the economy overheats or having them persistently.Inflation can originate from demand-side forces, supply-side forces or shifts in inflation expectations. Absent major shocks, inflation should align with the target over the long run. Despite inflation overshooting during 2021-22, inflation expectations in the U.S. remained anchored. Markets understood that the Fed would ultimately act to restore price stability.This highlights another benefit of central-bank independence and inflation targeting: predictability. A central bank free to counter economic extremes reduces the risk of excess inflation and unemployment, allowing households and businesses to plan with a reasonable degree of certainty.Investment considerationsWhile we do not expect the Trump administration to capture the Federal Reserve, continued pressure on central-bank independence is likely to weigh on the U.S. dollar DXY.Beyond monitoring the Senate as the primary institutional defense of the Federal Reserve, investors should also watch markets. So far, markets have remained calm, reflecting confidence that the Senate will preserve Fed independence. Long-dated inflation expectations, proxied through 5-year/5-year CPI swaps, are still stable.However, this calm could create a dangerous feedback loop. If policymakers interpret market stability as an endorsement of diminished independence, ironically markets could then break down. In that scenario, equities would fall, interest rates would rise and the U.S. dollar would weaken. This is not our base case, but the self-sustaining nature of market dynamics makes it a risk worth considering.Conversely, if checks and balances prevail without being weakened, it would reinforce the United States' position as a leading destination for global capital over the coming decades. Market calm is conditional on the Senate acting as a backstop to Fed independence. If that condition is misread, markets will break down.