Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

The S&P 500 hit a record high on Wednesday, as Wall Street rose broadly on expectations the Federal Reserve will lower interest rates next month and investor confidence that tech giant Nvidia's results will deliver another resounding 'beat'. 

More on that below. In my column today, I look at examples of where the overt politicization of monetary policy has had severe economic and market consequences. And contrary to perceived wisdom, these have not just been in emerging markets.

I’d love to hear from you, so please reach out to me with comments at jamie.mcgeever@thomsonreuters.com. You can also follow me at @ReutersJamie and @reutersjamie.bsky.social. 

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* Wings of a dove

Investors remain confident that the Fed will cut interest rates next month as the controversy around President Donald Trump's attempts to fire Fed Governor Lisa Cook persists. Traders are putting a near-90% probability on a move next month, and the 2-year Treasury yield fell to its lowest since May.

New York Fed President John Williams said rates are probably headed lower, but officials need to see more economic data before deciding if a cut next month is appropriate.  

* Stock rotation

The S&P 500 clocked a new high on Wednesday, led by the energy and healthcare sectors. As August draws to a close, the rotation into small cap and value stocks from tech and growth stocks shows no sign of reversing.

The Russell 2000 index has lagged all year but on Wednesday notched a new 2025 high, again outperforming Wall Street's big three indices. Will this continue next month? Much will depend on the impact of Nvidia's Q2 results, and expectations of what the Fed will do on September 17.

* China takes stock

Chinese stocks have been on a tear, roaring to decade highs earlier this week. But the AI-driven rally sputtered on Wednesday, and the Shanghai Composite slid nearly 2% for its biggest fall since the tariff turmoil of early April. 

It may just be natural profit-taking as month-end looms. But maybe the rally is stretched - Hong Kong's tech index is up 10% in August and up 60% from the April low, and China's economy is still not out of its funk: China's economic surprises index last week fell to its lowest level this year.

There is legitimate debate about the actual independence of modern-day central banks, but almost everyone agrees that overt politicization of monetary policy – as we appear to be seeing in the United States – is dangerous. Why is that?

Central banks are essentially arms of government, and many worked in close conjunction with national Treasuries in response to the Global Financial Crisis and pandemic, so absolute independence is a bit of a myth.

But what U.S. President Donald Trump is currently doing goes well beyond that. By threatening to fire Chair Jerome Powell, actively trying to sack Governor Lisa Cook, and attempting to fill the Board of Governors with appointees sympathetic to his calls for lower interest rates, he is shattering the Fed's veneer of operational independence.

Examples of the naked politicization of monetary policy down the years show that it can, to put it mildly, deliver sub-optimal results - loss of credibility, currency weakness, spiking inflation, rising debt, elevated risk premia, and, potentially, much higher borrowing costs. 

These are certainly far from guaranteed outcomes in the U.S., but they show where excessive political interference in monetary policy can lead.

TURKEY

"Erdoganomics", the unorthodox economic theories and policies of Recep Tayyip Erdogan, who has been President of Turkey since 2014, are a prime example of politicized monetary policy. Erdogan, an avowed "enemy" of interest rates, is on record as saying high interest rates cause inflation and that the way to reduce inflation is therefore to lower borrowing costs. 

He fired or replaced five central bank governors between 2019 and 2024, some for hiking interest rates or refusing to cut them. 

With inflation and interest rates hovering around 20% in late 2021, the central bank succumbed to Erdogan's pressure and slashed borrowing costs. The result? The currency collapsed and inflation soared above 85%.

UNITED STATES

In the early 1970s, President Richard Nixon pressured then-Fed Chair Arthur Burns to keep monetary policy loose ahead of the 1972 election even though inflationary pressures were building. 

Nixon also reportedly told Burns in 1969, just after he nominated him, that previous Fed chair Bill Martin was always six months "too late" doing anything. "I'm counting on you, Arthur, to keep us out of a recession," adding: "I know there's the myth of the autonomous Fed..."

Burns served as Fed chair for eight years through 1978, during which time inflation exploded and didn't fully come down until the early 1980s. Many observers consider him to be one of the least successful chairs in the Fed's history.

It barely needs saying that the U.S. is unlike any other country. Its economy and capital markets dwarf all others, the dollar is the world's reserve currency, and its rates and bond markets are the benchmarks for global borrowing costs. 

That means that the magnitude of any market or economic impact from Trump's political interference could very well be smaller than the ructions of the past. But America's global heft also means that the worldwide impact of these moves could be much greater.