US Fed’s Looming Shadow Chair
David Yang | 29 July 2025
Summary
As United States (US) President Donald Trump’s attacks on Federal Reserve (Fed) Chair Jerome Powell intensify, markets worry that Trump’s nominee to replace Powell, whose term ends in May 2026, will be beholden to political influence, raising risks for US macroeconomic stability.
The selection process for the new Fed Chair is reportedly underway. Trump will almost certainly choose a staunch advocate of interest rate cuts as he calls for lower US government borrowing costs and a hotter run economy.
An early announcement of a “shadow chair” who broadcasts their preferred rate policy while Powell remains as Chair will heighten US monetary policy uncertainty and erode the credibility of the Fed’s forward guidance. This will only further decrease confidence in the USD and raise long-term Treasury yields.
President Trump has relentlessly criticised Fed Chair Powell since assuming his Presidency in January 2025 over high US interest rates, culminating in a short-lived threat on 16 July to sack Powell over renovation cost overruns at the New York Fed, before Trump walked back when US assets fell in response. While the Fed has not cut the Federal Funds Rate (its main interest rate currently set at a range of 4.25-4.5%) since December 2024, Trump has called for rates to be as low as 1% to boost growth and lower borrowing costs as his recently passed tax cut is forecast to widen the US deficit by USD 2.8t.
Although Trump appointed the Fed Chair in 2018, his camp aims to replace Powell with one who adheres to his macroeconomic policy. Powell has directly cited inflation risks from Trump’s tariffs as the reason rates have remained elevated. Yet if Trump installs a replacement who rapidly slashes rates when US inflation remains stubbornly above its 2% target, inflation risks spiralling out of control, just as in 2021, reaching an annual rate of 7%.
Powell’s term as chair ends in May 2026, and a vacancy will open up on the Fed’s Board of Governors in January 2026, in which Trump can appoint his intended chair. Despite the speculation and threats, Trump is highly unlikely to fire Powell. In May 2025, the Supreme Court signalled that Fed officials are protected from the President’s ability to fire bureaucrats, making any attempt guaranteed to result in a lengthy legal battle. Such a move would also be catastrophic for markets as investors lose all confidence in the Fed’s independence, and would send the US dollar plummeting and Treasury yields soaring.
However, Trump will still not be able to control interest rates despite placing a favourable candidate. Monetary policy is decided by a majority vote on the 12-member Federal Open Market Committee (FOMC), of which only 2 are currently Trump appointees and the only members openly calling for immediate rate cuts. After the vacancy is filled, Trump’s next opportunity to appoint will be in January 2028, when Powell’s term as governor ends. However, by convention, chairs typically resign immediately after their term as governor ends. At most, Trump would have 4 loyalists on the 12-member FOMC, the rest being Biden appointees and regionally selected officials.
Instead of directly changing rates, the White House will likely opt to influence market expectations of future rates through an early nomination of Powell’s successor, a “shadow chair”, who would broadcast their intended interest rate policy, in all likelihood, deep rate cuts. This, Trump hopes, will reduce government borrowing costs through lower expectations of long-term interest rates and thus lower US Treasury yields. However, low rates combined with the effects of tariffs and tax cuts will likely spur inflation. Investors will then demand higher yields on government debt, achieving precisely the opposite of the desired effect by Trump. While consumer inflation expectations have soared above usual levels, market inflation expectations implied by the difference in yields between nominal and inflation-adjusted Treasuries have remained steady.
Furthermore, a shadow chair publicly dissenting against Fed policy would undermine its credibility. A key way the Fed manages inflation is by anchoring future expectations through forward guidance of interest rate policy. The median June FOMC projections of the Federal Funds Rate by end of 2026 were 3.6%, an increase from 3.4% in March’s projections, reflecting the Fed’s perception of increased inflation risk from tariffs and the widening deficit. If Trump’s loyalists publicly called for deeper cuts and dissented in conventionally unanimous FOMC rate decisions, it would obscure forward rate expectations and increase policy uncertainty, depreciating the USD as investors lose confidence in the Fed’s policymaking. Higher expected future inflation increases wage demands and current consumption, while a weaker dollar increases import prices, both of which contribute to inflation. Thus, the FOMC might find itself being forced to keep rates higher for longer in response to more dovish signalling from Trump’s loyalists. Trump’s desire to engineer dovish expectations might lead to more hawkish policy now, potentially lowering GDP growth and driving up Treasury yields as markets lose faith in the Federal Reserve’s credibility.
Forecast
Short-term (Now - 3 months)
Trump will almost certainly not fire Powell before the end of his term, but will likely name his nominee for the vacant governor seat in the next two months. Trump’s nominee to the open seat will be watched by markets as the presumptive “shadow chair”.
Increased uncertainty will likely drag down the USD and increase long-term Treasury yields.
Medium-term (3-12 months)
The Federal Reserve will likely make 2 more cuts in 2025, though this will be highly dependent on the coming inflation and unemployment data. Markets’ policy uncertainty is highly likely to increase as dovish signals from Trump’s shadow chair contradict the Fed’s current cautious forward guidance.
Long-term (>1 year)
Trump’s new chair will likely grow more independent through late 2026, as the Supreme Court’s protection will apply to them too and they are forced to build consensus among the FOMC. If Trump’s chair pick particularly worries markets, Powell will likely stay on as governor until the end of his term in 2028 to check Trump loyalists.
