Powell contends with double threat of economic chaos and political hostility

During a seven-year tenure that included Donald Trump’s first trade war, a pandemic, historic inflation and high-profile bank failures, Powell’s final act also unfolds with an imperative to preserve the institution’s apolitical DNA that protects its autonomy in setting interest rates.

Fed policymakers are alternately referred to as inflation-fighting “hawks" or labor-market defending “doves." Right now, Powell looks more like a duck—calm on the surface while constantly paddling beneath murky waters.

Inflation fell over the past two years as supply-chain bottlenecks eased and workforce participation rose. Now, tailwinds are becoming potential headwinds. Falling immigration and cuts to federal contracts risk hitting labor supply and demand. Dramatically raising tariffs could create an uncomfortable combination of weaker or even stagnant growth and higher prices.

Powell’s 18 colleagues who participate in monetary policy meetings have shifted their outlook. A few doves have become hawks, and vice versa. At least one has an eye on possibly succeeding Powell next year.

The Fed cut interest rates by 1 percentage point last year after lifting them to a two-decade high to combat higher prices. Inflation declined to around 2.5% in January from a recent peak of 7.2% in 2022. Officials are set to hold rates steady at their meeting this week.

Ahead of the latest trade-related swoon, acquaintances have tried to congratulate Powell on achieving a soft landing, even if for a brief time. The Fed chair has been too superstitious to agree. At a congressional hearing last month, he would only say that the economy had avoided a recession.

“I call that a soft landing," Sen. John Kennedy (R., La.) told him. “I don’t know why you don’t take the credit."

Trump’s latest trade war makes that tricky. When prices go up but growth falters, officials must choose between cushioning demand by lowering rates or preventing price increases by keeping rates higher.

“If the Fed does cut interest rates now, it’s only really going to be because the economy is getting much worse," said Dario Perkins, an economist at GlobalData TS Lombard.

Fresh on Fed officials’ minds is how they misjudged inflation when the economy reopened from the pandemic in 2021. Back then, officials initially believed rising prices would pass as supply chains healed. They ultimately abandoned the “transitory" thesis and began raising rates.

Trump’s Treasury secretary, Scott Bessent, said recently that Fed officials should treat tariff-related price rises like they did at first in 2021. “I would hope that the failed ‘team transitory’ could get back together and think that nothing is more transitory than tariffs," he said at a luncheon in New York this month.

If inflation accelerates in the months ahead, officials would parse the guts of inflation reports for signs that tariffs—as opposed to an overheated economy—were driving up prices.

“We call that a signal extraction problem," said Fed governor Christopher Waller in a recent interview. “You get this data point, and you’re trying to find the signal of what’s fundamental and what is maybe tariff noise, and that’s tough."

The shifting landscape is testing not just Powell’s economic chops but also his ability to manage a Fed board roiled by contrasting judgments and professional aspirations. A Fed that looks political would undercut the case for its so-called independence.

Trump’s election ricocheted through the Fed even before his inauguration. Michael Barr announced in early January that he would surrender his job as vice chair of bank supervision after concluding Trump would seek to fire him. He will remain on the board as a plain-vanilla governor.

Barr, a law professor, concluded that fighting a messy legal battle to keep his job wouldn’t be worth the reputational cost to the Fed. If Trump nominated and the Senate confirmed a replacement while Barr challenged his ouster, the Fed’s staff could have been stuck trying to answer to two different people who claimed to be in charge of bank regulation. In addition, Barr might have had to pay for any lawsuit out of his own pocket.

Barr’s self-demotion opened up a spot for another Fed governor to fill the role. Trump said on social media Monday he plans to nominate Michelle Bowmanto the job.

Bowman was appointed to the Fed by Trump during his first term, in 2018. After Trump’s election in November, Bowman delivered a speech before an invitation-only audience in West Palm Beach, Fla., near Trump’s home. Her remarks touted her vote against the Fed’s September rate cut. Trump advisers didn’t think the Fed should cut rates before the election.

Waller, the other governor appointed by Trump, has been viewed by Fed insiders as gunning for the chairmanship. He has lately signaled a more dovish posture toward rate cuts than was the case early last summer. In recent months, he has argued that the central bank should be prepared to continue cutting rates by looking through any tariffs.

In December, Waller deployed a Trumpy metaphor when describing the Fed’s challenge finishing its fight against inflation that made Fed observers giggle or groan.

“I feel like an MMA fighter who keeps getting inflation in a chokehold, waiting for it to tap out," Waller said. “Submission is inevitable. Inflation isn’t getting out of the octagon."

In the interview, Waller said his views hadn’t changed. As early as December 2023, he noted the prospect for the Fed to cut rates meaningfully if inflation declined. “I said this long before the election," he said. “So I don’t view that as anything remotely political. It’s just the data telling me what to do."

Other colleagues who were some of the most vocal advocates for frontloading the Fed’s rate cuts last year have signaled they should now return their focus to inflation. Last fall, Fed governor Adriana Kugler foreshadowed a hawkish turn by noting that a drop in labor force growth from falling immigration could undo progress on inflation, jeopardizing the case for continued rate cuts.

Chicago Fed President Austan Goolsbee, another advocate for rate cuts last year, also turned more vigilant on inflation. He signaled skepticism in a February speech about looking through tariff-related price increases by highlighting the lessons of Covid. “It is dangerous to assume away supply chain issues," he said.

In an interview, Goolsbee said his fundamental outlook hadn’t changed. “I keep saying, 12 to 18 months from now, rates are going to be way lower than they are today if we can just stay on the path" of declining inflation, he said. “I still basically think that’s true. I’m not hawkish."

After the election, Powell asked his colleagues to tighten up their communications to avoid saying things that could be seen as unnecessarily provocative toward the new administration. Kugler, a Biden appointee, delivered a speech on central bank independence one week after Trump’s election.

Six years ago, in his first term, Trump publicly badgered Powell to cut rates—but most of Trump’s senior advisers largely left the Fed alone. This time could be different. Advisers have suggested they regard the Powell Fed poorly.

“The people…who are running the Fed have made a lot of mistakes on inflation over the last years, starting with letting it get out of control by saying it’s all just supply disruptions and so on," said Kevin Hassett, Trump’s director of the National Economic Council, in a Bloomberg television interview last month.

While the administration says it isn’t trying to interfere with interest-rate policy, it has taken steps that could indirectly curtail the Fed’s independence or create new avenues to challenge the Fed.

An executive order last month would give the administration power to oversee the institution’s regulatory agenda and interpret laws on its behalf. Though it exempts monetary policy, there is ambiguity over how it might be enforced.

The confusion stems from a fundamental tension: If Fed governors can’t be removed for disagreements on monetary policy, does that mean they can be dismissed over disagreements on regulatory decisions? Powell has said little publicly except to note that the Fed typically tries to “align" its policies with executive orders.

Trump’s Justice Department has said it would seek to overturn a 1935 legal precedent that has protected presidential appointees at regulatory agencies from dismissal over policy disputes. That court ruling has long been cited as the primary guardrail supporting Fed independence.

“The Supreme Court could say, ‘No, you cannot fire members of these independent boards.’ Or they can say, ‘Yes, you can,’" said Waller. “At the end of the day, if the Supreme Court makes that decision, that’s the decision we have to live with."

Write to Nick Timiraos at Nick.Timiraos@wsj.com