Criminalising the Fed

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Today’s newsletter was done and dusted when the news hit that the justice department had launched a criminal investigation into Federal Reserve chair Jerome Powell. So we turned the computer back on and laid out some quick thoughts. It’s early, but this could turn out to be a defining moment in the history of the central bank, and a turning point for markets. Send us your thoughts: unhedged@ft.com. 

Criminalising the Fed

Donald Trump’s Department of Justice has subpoenaed the chair of the Federal Reserve and threatened him with criminal prosecution. The case concerns Powell’s congressional testimony about the cost of renovations to the Fed’s headquarters. Powell has stated bluntly that the case is nothing but an attack on the independence of the bank.

For markets and the economy, this is bad news. How bad depends on what happens next. Some points to keep in mind as markets respond and the story unfolds:

• The cost overruns at the two Fed buildings are significant, as my FT colleagues have reported, and the White House has long threatened to sue Powell “for incompetence”. But the idea that there is criminal misconduct involved is new, and, on the basis of the facts we have now, appears to be a remote possibility.

• If the DoJ has not uncovered important new facts, or delays laying out the meat of its case, both the Fed and markets have a serious problem. Powell’s term as Fed chair ends in May. It will be impossible, unless the case is established to have real substance, for any nominee to replace Powell to be taken at face value by markets or by the other members of the Fed’s Open Market Committee. The only possible assumption, under those conditions, is that any Trump nominee has been chosen because they are an enemy of Fed independence. And any candidate who would accept the nomination under these conditions has proven themselves unfit for the job.

• Ironically, the investigation makes it less likely that the Fed will cut interest rates again soon. Because until we know more, the case looks like such a bald attack on Fed independence that it provides a real reason for inflation expectations to become unanchored. So it would not be surprising to see expectations for short term rates rise in the coming days.

• How will markets react? Overnight, the response has been relatively mild, with gold rising a bit, the dollar weakening and US stock futures a touch lower. And a moderate reaction when US markets open today is more likely than a repeat of the “liberation day” panic. After all, the administration often backtracks, and overreacting to Trump’s worst ideas has proven to be a bad trading strategy. But in the absence of a strong market reaction, Trump might not backtrack, setting up the market for worse pain later.

Undoubtedly, we will write more on this in the days to come.

The jobs/growth puzzle

It says something about where we are, economically, that last Friday’s US employment report for December was greeted with relief on Wall Street. It hardly signalled a resurgence in labour demand. Below is a chart of private payroll additions. Acknowledging that the autumn numbers were distorted by the government shutdown effect on data collection, the trend is clear enough. Job additions are broadly stable but unpleasantly low:

Those numbers come from surveys of businesses. The survey of households contained marginally better news. The unemployment rate fell a bit, from a downwardly revised 4.5 per cent in November to 4.4 per cent in December. The slow pace at which unemployment is rising is unusual (Employ America calls it “unprecedented in the postwar data”) but it still appears to be rising:

It is also hardly cheering that the private job additions we are seeing are not in cyclical parts of the economy. If it weren’t for healthcare, the labour market would look very grim indeed:

It is standard to describe this job market as “no hire, no fire” and that is true as far as it goes. Lay-offs have been fairly steady at between 1.6mn and 1.7mn a month for a year or so, a level very consistent with the pre-pandemic years.

For Wall Street, however, stability at a low level constituted good news. The consensus is the report makes a rate cut in the next few Fed meeting significantly less likely. Marc Giannoni of Barclays is a good example of the sentiment:

Today’s employment report for December was solid . . . We think it provides the first “clean” read on the labor market, following distortions to the estimates for October and November . . . Taken alongside other indicators, including the ongoing absence of lay-offs in weekly jobless claims, we suspect that most of the FOMC will conclude that downside risks to the job market have diminished.

Stability is better than decline. But I still don’t quite understand how an economy that appears to be growing at 2 per cent in real terms, where consumption has been sturdy, business investment is growing and corporate profits are expanding, can generate so few new jobs. I can think of 5 (possibly complementary) solutions to this persistent puzzle: 

A labour supply shock. The abrupt reduction in the number of migrant workers, ageing demographics and the Covid shock pushing some workers permanently out of the workforce combine to limit the worker pool. Here’s Bank of America’s Shruti Mishra, in November: 

The supply shock from tighter immigration policy is likely to be the bigger driver of soft job growth [in 2026], especially as labor demand starts to recover on the back of fading tariff uncertainty and a positive impulse from fiscal policy . . . Immigration policy has tightened via mass deportations, cancellation of humanitarian/work authorization programs, stricter border policy enforcement and some increased restrictions on legal immigration . . . We estimate net immigration of -348k people over the course of the coming year.

She thinks this puts break-even job growth — the number of job additions consistent with a steady unemployment rate — at 20,000 a month, about where we have been in recent months.

There is not much hiring, on this view, because businesses can’t find the right people to do the jobs they need done. So they turn to other methods to grow. Which leads us to . . .

Productivity. In the third quarter, US business productivity rose almost 5 per cent, the second straight quarter of strong gains. This is no comfort to a young, unemployed American, but does help with the growth/jobs puzzle. Here is the BLS’s chart from last week, showing output rising with productivity, while hours worked more or less stagnate: 

What is driving productivity? It could well be that we are still reaping the benefits of the very tight post-pandemic job market, which pushed people towards higher paid, more productive work. But it could also be . . . 

The robots. “The latest surge in US productivity suggests the AI boom is providing lasting benefits to the US economy that go well beyond just the value of investment in data centres,” writes Paul Ashworth of Capital Economics. “Suggests” is doing a lot of work here; it’s very hard to know how many businesses are using AI tools so successfully that they can forgo hires that they would have otherwise made. But there is enough anecdotal evidence from fields such as software development and customer service that we must take the possibility seriously. More seriously, in any case, than the idea that weak hiring is down to . . . 

A K-shaped economy. It is perhaps possible that the weakness in hiring is a signal from the bottom half of the economy, dominated by sluggish sectors from manufacturing to transport to fast food, whereas cheerful aggregate growth is driven by a tech boom and rich people indulging in luxury goods and services. But Unhedged has argued in the past that we don’t quite believe this. Inequality in wealth and income have not risen in recent years (if anything, they have fallen a bit). Yes, inflation has been highest in essentials such as food, which hits poorer Americans harder, causing them to tighten their belts and possibly weakening demand for some classes of goods and some forms of work. But there is little evidence that high earners’ spending is a more dominant share of consumption now than it was before the pandemic, as many have claimed. There is little doubt however that people feel badly about the economy, which leads us to . . . 

Business sentiment. We’ve had a fair amount of policy uncertainty in the past year or so, especially around tariffs and immigration. Perhaps businesses are hesitant to hire, despite good current conditions, because they are worried about what is coming next. Here is the hiring intentions section of the National Federation of Independent Business optimism survey. It was recovering for much of 2024, fell again in the spring and has been recovering since. Might hiring pick up soon?

All of these explanations have some part to play in solving the puzzle, but I’m still not quite satisfied. If you have other clues, send them along.

One good read

Kidnapped by idiots.