The US Department of Justice has opened a criminal investigation into Federal Reserve chair Jerome Powell. Officially, the case concerns the renovation of government office buildings in Washington. No one should pretend to be naive enough to take that explanation at face value.
This is a frontal assault on the independence of the world’s most important central bank. For institutional investors, it marks the beginning of a period of higher risk premia and creeping erosion of credibility. What we are witnessing in real time is precisely the dynamic described by economists Vasso Ioannidou, Sotirios Kokas, Thomas Lambert, and Alexander Michaelides in their recent paper, (In)dependent Central Banks.
Response by Federal Reserve chair Jerome Powell
Their research shows that the legal independence of central banks, long celebrated as a triumph of the 1990s, has a dangerous blind spot. When politicians lose formal control over interest rates by law, they do not give up power. They look for alternative routes to reclaim it.
The authors describe this as the “seesaw effect.” When the door to direct political instructions is closed, politicians climb in through the window, using appointments, pressure, and intimidation. In Trump’s case, the strategy is unusually blunt. If the sitting technocrat cannot be fired outright, the legal system is used to paralyze him, while the rest of the board is gradually replaced with loyalists.
Material risk
For investors, this is not political theater. It is a material risk to portfolios. The paper is unambiguous about the consequences of political interference. Politically motivated appointments are consistently associated with worse economic outcomes, including higher inflation and a greater likelihood of debt crises. The data show that a decline in a central banker’s independence correlates directly with an increase in inflation of nearly half a percentage point.
Politically motivated appointments are consistently associated with worse economic outcomes, including higher inflation and a greater likelihood of debt crises.
When a central banker listens to the president rather than the inflation data, he forfeits his only real capital: credibility.
Markets tend to respond ruthlessly. Using an event study, the authors show that the appointment of an independent central bank chair is followed by higher bond yields and a stronger currency. Investors reward credibility. The reverse is now unfolding. The intimidation of Powell implies that the so-called Fed put is no longer grounded in economic judgment, but in the electoral preferences of the White House.
Once investors suspect that rate decisions are being shaped to engineer a “new golden age” rather than to safeguard price stability, the anchor disappears. Expectations drift, risk premia rise, and volatility follows.
Paper shield
The criminal investigation into the Fed’s renovation costs is a transparent instrument of coercion. Institutional investors would do well to absorb the lesson from Ioannidou and her co-authors. De jure independence is a paper shield if political pressure on individuals becomes overwhelming.
The refurbishment of the Fed’s buildings may indeed be messy. The attempted renovation of American monetary credibility by the Trump administration is far more dangerous. Investors who rely solely on legal safeguards forget a basic political truth: politicians always find a way to tilt the seesaw back in their favor. If Powell falls, the Fed’s independence falls with him, along with the stability of bond portfolios that depend on it. As of January twelve, the hunt is on, and the bill will be presented to investors.
Gertjan Verdickt is assistant professor of finance at the University of Auckland and a columnist for Investment Officer.