Viewpoint

April 25, 2025 | 13:48

April 25, 2025

Economist

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Priscilla Thiagamoorthy

Senior Economist and Vice President
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Priscilla Thiagamoorthy

Senior Economist and Vice President
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Our Thoughts

The Direction of Travel Is Clear

The direction of travel is clear, though the final destination is still uncertain. We got more evidence this week that the economy is about to weaken materially. Case in point: the Conference Board’s Index of Leading Economic Indicators plunged 0.7 pts in March, the fourth consecutive month of decline and the largest drop since October 2023 (Chart 1). These ten leading economic indicators have historically been a reliable signal of turning points in the economy and have tended to lead business cycle turning points by around 7 months. The sharp decline in March was largely driven by consumer expectations, stock prices, and the ISM New Orders Index along with more modest deterioration in the leading credit index and interest rate spread (Chart 2).

Another concerning development: service sector out-performance may be evaporating. The services side of the economy, responsible for approximately 86% of employment and 78% of GDP, many be slowing faster than the goods-producing side right now. The preliminary reading of S&P Global’s Purchasing Manager Indexes for April revealed a bigger-than-expected deterioration in the service sector PMI (Chart 3). Since December, the service PMI has moderated from a robust 56.8 to a meager 51.4 in April—though PMIs for both services and manufacturers remain modestly above the 50.0 threshold that implies outright contraction. First quarter GDP growth is expected at an anemic 0.4% a.r. as a rebound in equipment spending growth isn’t enough to offset a spooked U.S. consumer and a surge of imports. So, while these trends are concerning, outright signals of recession are not quite there yet either.

Mixed signals are also coming from the labor market. We know layoff announcements are piling up. According to the latest Challenger, Gray, and Christmas data, layoff announcements jumped to over 275k and are up 204% from a year ago—the highest level since the early days of the pandemic. But diving deeper into this data, we see the bulk of the announcements so far are coming from the government sector, likely driven by DOGE cuts (Chart 4). Layoffs for most private industry sectors remain fairly muted. This is borne out by the steady initial jobless claims data that came in at only 222k last week, just a touch above the 4-week average (220k) and still below the twelve-month average of 226k. Looking ahead to the employment report released next Friday, we expect to see a slowdown in nonfarm payroll growth for April to around 130k, from 228k in March, as many employers hold back on hiring on a deteriorating outlook for demand and profits. We are also expecting a modest uptick in the jobless rate to 4.3% and a decline in the average work week to 34.1 hours as labor demand slackens on rising uncertainty.

Until trade policy uncertainty and its implications for supply-chain disruption and inflation subside, we expect more and more sectors of the economy will be taking a time-out until the path forward is clearer. This includes officials at the Federal Reserve, who will likely need to maintain their policy rate at its current level for a few more months even as the economic and financial clouds darken. It will take at least that long before they have a better handle on the stagflationary effects from these new tariff polices and the proper course for U.S. interest rate policy. Until then, we will just be watching our social media and the daily volatility in our stock portfolios, looking for the latest tariff developments and pronouncements from the White House; hoping for the best, but preparing for the worst.

Fed Independence Under Fire?

You’re (Not) Fired

In trade-mark style, President Trump recently said he has “no intention” of firing Fed Chair Powell only days after threatening to do just that. In a reprise of his first term, the President had assailed Powell for not cutting interest rates to support the economy’s flagging momentum. In 2018, the Fed was tightening policy to curb inflationary pressures, while, today, the debate centers more around when policy easing will resume. According to the Wall Street Journal, Trump changed his mind after aides, including the Treasury and Commerce secretaries, advised him that dismissing Powell could cause further market turmoil. Of course, he could have another change of heart and resume calling for Powell’s dismissal, begging the question: Can he actually remove the chair before his term ends in May 2026?

The short answer: not easily. Presidents do not have explicit legal authority to fire Federal Reserve Board members. As an independent agency, the Fed hires and fires its own personnel. However, the Federal Reserve Act stipulates that board members shall serve 14-year terms unless removed “for cause” by the President. While the Act does not define “cause”, it typically refers to misconduct or malfeasance—not disagreements over policy. Still, this leaves an opening for the President to challenge Powell’s position in court. In fact, Trump has recently asked the Supreme Court to remove two members of federal labor boards—also independent agencies—arguing that the “for cause” restriction is unconstitutional. Should the Court rule in his favor, it could embolden him to attempt the same with Powell or other Fed governors.

The Benefits of Independence

Independence from political influence is widely regarded as essential for the Fed to fulfill its dual mandate: price stability and maximum employment. This twin goal is inherently difficult to achieve, and involves a delicate balancing act, since policy changes often affect inflation and growth in opposite ways. Lowering rates boosts growth but could also feed inflation. Political influence, especially when driven by short-term goals such as stimulating the economy or reducing unemployment, can lead to overheating, compromising the economy’s long-term health. If the Fed is forced to tighten policy abruptly to arrest inflation, the economy could slip into recession—with negative implications for financial markets.

Central bank independence is critical for maintaining long-term stability of both inflation and growth. The Fed’s credibility is easier to uphold when investors, businesses, and consumers believe it is fully committed to price stability and insulated from political interference. Under these conditions, inflation expectations are more likely to remain anchored to the inflation target, reducing the need for aggressive actions.

The President’s recent threats to fire the chair might explain recent selling pressure in U.S. assets—including stocks, Treasuries, and the dollar. At a minimum, uncertainty alone appears to have contributed to heightened market volatility. Should the President move to replace Powell with a more compliant (i.e., dovish) successor, Treasuries could come under renewed pressure. And lest we forget, U.S. monetary policy is decided on by 12 members of the Federal Open Market Committee including the Chair, six other Board members, the president of the New York Fed, along with four other rotating regional Fed presidents.

History Lessons

Although no other president besides Trump has openly threatened to fire a Fed chair, history offers a few precedents that raised similar concerns about central bank independence:

In the 1960s, President Johnson reportedly pressured William McChesney Martin Jr. to lower interest rates to support economic growth during the Vietnam War. This may have contributed to a meaningful pickup in inflation in the mid-1960s and the subsequent need for tighter monetary policy.
In the early 1970s, President Nixon pushed Arthur Burns to ease policy ahead of the 1972 election. Many analysts believe this contributed to a prolonged era of stagflation—high inflation coupled with sluggish growth. Long-term inflation expectations surged, complicating the Fed’s efforts to curb runaway prices.
A more extreme case occurred in Argentina around the start of the century when a collapsing economy—real GDP shrank 28% over a four-year period—was accompanied by hyperinflation and currency devaluation. The crisis was likely exacerbated when the government dismissed the central bank head in 2001.
A more recent example of where government interference with the central bank led to hyper-inflation was in Turkey. The central bank chief was replaced with another who slashed policy rates, sending the annual CPI rate to 86% in October 2022.

These episodes indicate that compromising the Fed’s credibility as an independent policymaker for short-term political gains could be a costly mistake.

The Fed’s complicating ‘dual mandate’

Among G7 central banks, the Federal Reserve is the only one with a ‘dual mandate’ to promote both price stability and maximum employment. The others (Bank of Canada, Bank of England, European Central Bank, and Bank of Japan) have sole mandates to promote price stability. Note that, in 2021, the Bank of Canada was charged with taking into account the deviation from maximum employment, but only as a secondary consideration; the primary focus is still on price stability. Among the world’s other central banks, price stability is the most frequent monetary policy goal with ‘financial stability’ being a common co-mandate. A much smaller set of global central banks sports policy mandates with a second economic aim.

The reason for the smaller group of dual economic mandate practitioners is that it’s harder to craft and communicate monetary policy. It’s an easier choice when inflation is persistently above target, and the economy is close to full employment (a case for restrictive policy). Or, when inflation is persistently below target and there is lots of labour market slack (a case for accommodative policy).

The tougher decision is when the policy environment has elements of both extremes, such as in stagflation. The Fed’s formal guidelines aid in crafting policy in these cases. They say: “The Committee’s employment and inflation objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.” Amid the unfolding stagflation shock from tariffs, we reckon that compelling evidence of employment dropping, or being on track to do so, will trump any inflation concerns because current policy is still on the restrictive side. But short of this, the Fed’s focus will likely tilt to tariffs’ immediate inflation impulse, delaying rate cuts for a few more months.

What investors should watch for in the months ahead?

U.S. import prices are poised to rise owing to tariffs. And we wouldn’t be surprised to see the prices of (domestically produced) import-competing goods also increase—but to a noticeably lesser degree. With inventories of imported items having surged in anticipation of tariffs, these price impacts could be delayed until inventories are depleted. However, as the impacts unfold, they will, in aggregate, contribute to a one-time jump in the general price level. Measured by the change from a year earlier, this will show up as a meaningful increase in inflation from its pre-tariffs level for the next 12 months.

The main worry for the Fed is whether this one-time tariffs-prodded jump in the price level causes any second-round or feedback pressures; say, if wage growth picks up to make up for higher retail prices or businesses use the ‘veil’ of tariffs to pad their profit margins. The Fed has an ally here. Economic growth is going to slow owing to tariffs’ erosion of purchasing power and any retaliatory measures, which should guard against second-round pressures. Moreover, the recent deep pullback in oil prices will also help contain headline inflation in the near term. Beyond a month or two of inflation reports, the Fed will be scouring the data for any indications of feedback pressures in the month-to-month moves. The Fed won’t wait around until the initial influence of tariffs falls out of measured inflation. But no matter how long the Fed delays easing, it will still likely be too long for the Trump Administration, if recent events are any guide.

With Fed policy still on the restrictive side, we expect the FOMC will resume rate cuts before the end of the summer, presuming we get at least a couple of subdued month-to-month inflation readings after the immediate tariff lift. The wait will also be determined by whether economic and labour market performance softens materially, which we believe it will. Communicating rate cuts amid annual inflation rates running in the 3%-to-4% range will take some skill, particularly with the Administration likely to take credit for causing the Fed to act.