Donald Trump's dispute with the US Federal Reserve has reached historic levels, with the central bank under siege as the President drags it into an unprecedented legal battle.
At stake is the very notion of the Fed's independence, which underpins stability of global financial markets and the role of the US dollar as the world's reserve currency.
For months, Mr Trump has chipped away at this belief that most economists hold sacrosanct. He has repeatedly denigrated Fed chairman Jerome Powell, made a surprise visit to the Fed's headquarters in Foggy Bottom and nominated his top economic adviser to serve on the board of governors in a temporary capacity.
These attack channels have grown more numerous as Mr Trump has become increasingly irate over the Fed's refusal to lower interest rates despite his demands.
Mr Trump wants to slash rates to help service the nation's debt, a concept known as fiscal dominance. Exerting greater control over the Fed, which has held rates steady at around 4.33 per cent this year because of economic uncertainty surrounding tariffs, could help him achieve that.
This week, Mr Trump crossed a line none of his predecessors had stepped over: firing a Fed governor.
“We've never seen a direct attack like this,” said Derek Horstmeyer, a professor at George Mason University.
George Mason University
Unprecedented steps
The woman at the centre of the political maelstrom is Fed governor Lisa Cook, a Biden-era appointment to the Fed board and a permanent voting member on the rate-setting Federal Open Market Committee (FOMC). She has consistently voted in line with Mr Powell on monetary policy decisions.
Kevin Hassett, a top economic adviser to Mr Trump, on Wednesday defended the President's decision to fire Ms Cook, even though no charges have been filed against her, and said she should remain on leave until the situation is resolved.
A lawyer for Ms Cook said she intends to file a lawsuit against the President.
“President Trump has no authority to remove Federal Reserve governor Lisa Cook. His attempt to fire her, based solely on a referral letter, lacks any factual or legal basis," said Abbe Lowell, Ms Cook's lawyer.
A Federal Reserve representative noted that “Congress, through the Federal Reserve Act, directs that governors serve in long, fixed terms and may be removed by the president only 'for cause'". The phrase “for cause” generally means malfeasance or neglect of duty.
The Federal Reserve and Mr Trump said they would abide by the court's decision on whether he has the legal authority to fire her. “The Federal Reserve will continue to carry out its duties as established by law,” the Fed representative said.
A Supreme Court ruling this year upheld the notion that legal reasoning the White House has used to fire officials at other independent federal agencies does not apply to the Fed.
“The Federal Reserve is … a quasi-private agency that is designed to be completely free from political interference,” said Jay Zagorsky, a professor at the Questrom School of Business at Boston University.
Mr Powell said in November the President does not have the authority to fire him or demote other Fed officials. “Not permitted under the law,” he said at the time.
The Fed's quagmire
The next steps facing the Fed could be read in a chapter of a legal thriller novel.
By firing Ms Cook, experts suggest Mr Trump can install a loyalist on the seven-member Federal Reserve Board of Governors, who hold permanent votes on the rate-setting FOMC.
That would help him secure a four-person majority on the board after Fed governor Adriana Kugler's surprise resignation allowed him to place his top economic adviser Stephen Miran on the committee temporarily. "We’ll have a majority very shortly," Mr Trump said on Tuesday.
One potential theory is that by installing a board of loyalists, the Fed board could move to dismantle the independence of regional Fed banks next year, sidelining Mr Powell and removing any obstacles to Mr Trump's rate-setting demands.
“If you have control of the Board of Governors for the FOMC, you have control and you can sideline all the regional banks,” said Mr Zagorsky, a former economist at the Federal Reserve Bank of Boston.
Such a move at this point is speculative, and it remains unclear if Fed governors Michelle Bowman and Christopher Waller – two Trump appointees who are in contention to become the next Fed chair – would go along with it. Both have recently voiced support for the Fed's independence.
The unfolding drama comes three weeks before the Federal Reserve's next two-day meeting, where it is expected to cuts interest rates, albeit not at the magnitude Mr Trump wants.
Boston University
For now, Ms Cook remains firm that she will carry on with her work as normal. If so, she seems set to participate in the Fed's September 16-17 meeting.
“Would Powell let the Fed let Cook stay in office as governor, which might put the whole Fed and FOMC at risk? Or does he agree with her about drawing the line here?” wrote Derek Tang, an economist at LHMeyer / Monetary Policy Analytics.
And Mr Powell must soon answer the question of his own future at the Fed. While his term as Fed chairman expires in May 2026, his term as governor runs until January 31, 2028.
He has provided no clues on his future thus far.
Wall Street muted, Treasuries tested
Initial market reaction to the developments have been muted, a stark contrast to July, where reports that Mr Trump had drafted a letter firing Mr Powell sent Wall Street indexes tumbling. Markets rebounded after Mr Trump said he would not try to oust the Mr Powell.
While US markets were little changed ahead of Nvidia earnings on Wednesday, the yield curve steepened, indicating unease in the bond market.
"We think the circumstances are ripe for the steepening to accelerate again over the near term," wrote Adam Slater, lead economist at Oxford Economics.
Yields on the two-year Treasury, which is sensitive to Fed rate moves, fell two basis points to 3.652 per cent.
Long-term yields continued their rise, with the yield on the 30-Year Treasury rising to 4.952 per cent and the 10-year yield rising to 4.281 per cent.
This could have an adverse effect on mortgage rates and housing cost, which could run counter to Mr Trump's argument that lowering the federal funds rate will make housing more affordable.
“As these long-term rates creep up, this means this affects day-to-day people,” Mr Horstmeyer said.
Experts argue that the Fed's independence plays a crucial role in financial stability because of the central bank's long-term approach towards price stability.
“Financial markets rely on that,” said Paul Poast, a professor at the University of Chicago.
Meanwhile, the dollar, which is underpinned by the Fed's credibility, could come under greater strain because of politicised actions. Many of the transactions in the world are made in US dollars, which are underpinned by the Fed's credibility as a rate-setting institution.
“If the Federal Reserve's credibility suddenly comes under question because of these kind of political manoeuvres by Trump, that adds to questions about the dollar, which then jeopardises all of these various markets that use dollars to be able to conduct transactions,” Mr Poast said.
