How the attacks on the Fed could backfire

While that outcome would disappoint financial markets, other efforts by the administration to reduce borrowing costs for consumers and home buyers may have some limited impact. That may provide a political fillip ahead of November’s midterm elections but not much more. Still, Main Street would fare better than Wall Street as the current White House resorts ever more to the Nixon command-and-control economic playbook.

The conflict between the White House and the Fed escalated this past week with Chair Jerome Powell’s strong rebuttal against the Justice Department’s criminal investigation into the his congressional testimony regarding the central bank’s renovation of its office buildings. The Georgetown law graduate sharply changed tacks in dealing with his critics, from President Donald Trump on down. Instead of calmly parrying their jibes, as he has in the past, Powell counterpunched, contending the allegations were pretexts to get the central bank to lower its interest rates.

Perhaps as stunning was the reaction of the financial markets—that is, their lack thereof. Currencies, bonds, and stocks appeared to be nonplussed. Whether the markets were surprised, confused, or simply unperturbed can’t be inferred definitively. In any case, no one seemed to see the skies falling.

Maybe it was because, as James Grant, eponym of Grant’s Interest Rate Observer and a Barron’s alum, observed, Powell was being charged with the equivalent of spitting on the sidewalk—overseeing cost overruns on a Fed building-renovation project. That is, as opposed to what he says is the malfeasance of Fed policies that inflated asset prices and lie at the center of the affordability crisis besetting America (of which more later).

As expected, other Fed officials closed ranks behind the chair and the organization this past week to defend the Fed’s independence against political interference. And a number of them also spoke out against further near-term rate cuts following the reduction over the past two years totaling 1.75 percentage points in the key federal-funds rate target range, to 3.50% to 3.75%.

Among the speakers, Jeff Schmid, president of the Kansas City Fed, and Austan Goolsbee, president of the Chicago Fed, emphasized the need to bring down inflation, which has stubbornly remained well above the official 2% target. The two had dissented on the Fed’s December rate cut. Moreover, it isn’t a stretch to think that Fed officials might be less inclined to cut lest it be seen as knuckling under political pressure.

Indeed, Michael Feroli, J.P. Morgan’s chief U.S. economist, looks for no further reductions in the Fed’s policy rate in 2026, with the next possible move to the upside coming in 2027. Improving job growth and gross domestic product, along with core inflation above 3%, argue against rate cuts. By contrast, the median expectation among Fed officials is for one quarter-point cut by year end, and the futures market has priced in two cuts by then, according to the CME FedWatch tool.

With the Fed and the bond markets less likely to lower financing costs, the Trump administration has sought other ways to cut rates for consumers in this key election year. Trump has asserted that banks will have to cap credit-card interest rates at 10%, far below the typical 20%-plus charge, or risk violating the law, although no such regulation exists. Bank executives, as expected, have pushed back against the notion, arguing that price caps would restrict credit for consumers with less-than-perfect credit scores.

By contrast, the administration has had some success in muscling down mortgage rates, with the aim of improving housing affordability. The main mortgage agencies, Fannie Mae and Freddie Mac, recently made additional purchases of $200 billion of mortgage-backed securities.

The yield differential between agency MBS and the benchmark 10-year Treasury has steadily narrowed, helping to bring new 30-year home loans to just over 6%, near the lowest since 2022, and down sharply from almost 8% in October 2023.

Both the 10% cap on credit-card rates and GSE mortgage buys indicate the White House’s willingness to use unconventional means to lower borrowing costs for end users, write BMO rates strategists. But, counter BCA Research strategists, the administration isn’t likely to see further tightening in mortgage spreads.

Another novel tool to improve housing affordability remains on the policymakers’ shelves. Harley Bassman, the former head of mortgage operations at Merrill Lynch who pens the Convexity Maven blog, contends the “housing log jam" could be broken by allowing “portability" of outstanding mortgages.

Current homeowners who locked in 3% mortgages a few years ago can’t afford to move even into a lower-priced house, let alone trade up, even though home loan rates are down to 6%. The answer, Bassman writes, to make that 3% loan portable, so the borrower can use it for a new home. This portability already exists in Canada, Australia, and the United Kingdom. Housing turnover should increase under this system, allowing people with lower-rate mortgages to move more easily as their personal circumstances change, say, for new jobs or retirements.

As I wrote last month, we’re likely to see increased use of direct controls to bring about favorable economic results ahead of the midterm elections. The legal assault on the Fed fits that description. But as the history of the 1970s shows, these measures have negative longer-term consequences. Nixon’s wage-and-price controls, combined with pressure for easy Fed policies, led to the stagflation of that dreary decade. That lesson seems to be forgotten.

Write to Randall W. Forsyth at randall.forsyth@barrons.com