President Trump’s long-term campaign to bring the Federal Reserve to heel just received a significant boost. With the resignation of Governor Adriana Kugler, the president has a prime opportunity to fill the central bank with a loyal supporter. However, as the aftershocks subside, experts warn: stripping the Fed of its independence, while a distant scenario, sets the stage for an economy saturated with risks and debt. In a worst-case scenario, it could lead to a world where the dollar’s safe-haven status is lost forever. “Stripping the Fed of its independence and setting monetary policy to maximize short-term economic growth will lead to a very concerning escalation of long-term debt imbalances. It will also increase the instability of the U.S. economy and financial system, assuming the initial positive ramifications for growth are not cut short by a full-blown bond market revolt,” MRB Partners said in a recent note.

A Dangerous Extension of the Debt Supercycle and a Shift in the Treasury Market

The initial impact of a political Fed would likely be felt in the bond market as lower interest rates encourage policymakers to ratchet up the debt to quench their thirst for faster economic growth. But this “significant extension” of the U.S. debt supercycle is no free lunch: “Such a policy could create a prolonged period of above-potential economic growth, but at the expense of increasing longer-term economic and financial instability .” The Treasury market would likely pivot sharply toward short-term notes, abandoning long-term government bonds to cut interest costs. But this move would be fraught with risk: debt service costs would be dangerously tied to short rates, making U.S. debt more volatile. The long end of the yield curve would become less liquid, and the true cost “savings” may be overstated, MRB said. President Trump is calling for deep Fed interest rate cuts as this would dramatically reduce debt servicing costs, although MRB claims the cited savings are overstated according to their calculations.

The Private Sector and the Threat to the Dollar: From Floating-Rate to a Crisis of Confidence

The private sector would likely not be left unscathed. If short rates begin a race to the bottom, corporations may abandon long bonds in favor of cheaper floating-rate loans. Mortgage lenders could revive floating-rate mortgages, “improving affordability” and potentially reviving the U.S. housing market, albeit temporarily. But as MRB warns, boosting housing demand in this way sows the seeds of “even higher house prices” and heaps new risks on the financial system. “This change would allow banks to use their large deposits and may thaw the frozen housing market by improving affordability, at least until house prices re-spike. New homeowners may intend to refinance… but such a day may never arrive,” MRB warned.

Ironically, the Fed’s day-to-day influence on the economy would grow. As households and businesses tie their fate to ultra-low short-term credit costs, any tightening cycle would carry a much greater impact, making the entire economy especially sensitive to the central bank’s moves and increasing the risks of an unintentional recession. “Over time the economy will also become dependent on short-term interest rates remaining very low… the Fed will be more hesitant to hike policy rates, even if inflation becomes problematic,” MRB said.

The endgame could be a threat to the dollar itself. If confidence in the U.S. government’s willingness, or ability, to pay its debts is ever shaken, MRB warns of a grim scenario: markets could shun even Treasury bills, forcing the Fed to print money and directly buy government debt. This is no longer just monetary policy, but a fast track to losing the dollar’s status as the world’s reserve currency. “In this extreme outcome, the Fed would become a buyer of last resort and eventually monetize U.S. government debt. However, this would end the U.S. dollar’s global reserve currency status .” The party may feel good in the short term, but “nurturing debt imbalances may create a raucous party, but it will eventually… end in a painful hangover or potentially an overdose .” Even if this scenario remains unlikely, for anyone with a multi-year horizon, the risks are too great to ignore.