Federal Reserve Chairman Jerome Powell’s first six months on the job were smooth sailing. The past six have been the opposite.
He has learned that the economic outlook can change suddenly, that communicating with jittery markets is harder than it looks and that President Trump isn’t likely to make his job any easier.
Looking ahead, Mr. Powell will have to apply what he’s learning to a question that could define his term—whether to cut interest rates at coming meetings to keep the economy growing.
The Fed chairman is navigating three discrete challenges: setting a policy to extend what is already a 10-year-old expansion, explaining clearly why the Fed does what it does, and ignoring the loudest public Fed badgering from a president in recent memory.
“The Fed is always a lightning rod,” said Julia Coronado, founder of economic advisory firm MacroPolicy Perspectives. “Right now, there’s a lot more lightning.”
Mr. Trump called into a CNBC news program on Monday morning and complained about policy under Mr. Powell, who goes by Jay. “They made a big mistake. They raised interest rates far too fast,” Mr. Trump said. “It’s more than just Jay Powell. We have people on the Fed that really weren’t—you know, they’re not my people.”
Mr. Trump’s hectoring of the Fed—over and over through the past year, in tweets, interviews and extemporaneous remarks—has persuaded some investors that the Fed’s decision to shelve plans to raise rates this year came in response to the White House. Investors also haven’t understood what Mr. Powell is saying at times, fueling more confusion.
Mr. Powell’s game plan is to tune out the president. The more he does, the more demanding Mr. Trump gets. After the Fed signaled early this year its pivot away from raising rates, Mr. Trump started calling for rate cuts.
Such a stance could boost the economy and help the president as he runs for re-election. The recent escalation of trade tensions has also fueled worries about a sharper growth slowdown that could force the Fed to act by cutting rates. A weak jobs report on Friday added to the concerns.
Shortly after Mr. Powell unveiled the policy shift in January, administration officials arranged an awkward dinner between him and the president at the White House residence. It happened to fall on Mr. Powell’s 66th birthday.
A few weeks later, Mr. Trump surprised his advisers and Mr. Powell by calling the Fed leader on his cellphone to discuss a disappointing jobs report. “I guess I’m stuck with you,” the president told Mr. Powell, according to the president’s later recounting of the call to supporters.
Mr. Trump’s advisers are generally uneasy about public attacks on the Fed, according to people who have spoken with them. A few believe the Fed is already thinking of lowering rates no matter what the president wants.
White House economic adviser Lawrence Kudlow has rejected the idea that Mr. Trump’s comments harm the Fed’s credibility. “We have our views. You can have your views without breaking the independence of the Fed,” he told reporters in April. Asked about Mr. Powell’s reaction to Mr. Trump’s criticism, Mr. Kudlow said, “I think he handled it pretty well.”
A look at how the Fed made decisions over the past six months—based on interviews with current and former Fed officials, White House advisers and market participants—shows the challenge facing Mr. Powell and the Fed now, at a time when so much about the economy is riding on how trade disputes with China and other countries work out.
When Mr. Powell became Fed chairman in February 2018, the central bank’s models suggested inflation was likely to rise given declining unemployment, tax cuts and a federal spending increase.
Mr. Powell isn’t trained as an economist and has a more plain-spoken approach than his predecessors. He initially thought this would be a strength, and it has been useful in speaking with lawmakers and the wider public or when the economy produced fewer surprises.
His first year in office showed this breezy style can also be a liability, because an unforgiving audience—asset investors—parses a Fed boss’s every word.
During an on-stage interview in October, Mr. Powell spooked some listeners with an off-hand comment describing interest rates as a “long way” from a neutral setting that neither spurs nor slows growth. Investors took the remark to mean he thought rates needed to rise more than they were expecting.
Mr. Powell had an even rougher time in December, when the Fed pushed through its fourth increase of the year in short-term interest rates to get them closer to normal and control future inflation pressures.
Most Fed officials, in September, had penciled in one more increase by the year’s end. Through the fall, however, they knew the case for higher rates was weakening, owing to a slowdown in Europe and escalating trade tensions with China. They began strategizing how they might slow their pace of quarterly rate increases—yet weren’t convinced they should stop, either, since the US economy still looked healthy.
Mr. Powell thought they could strike the right balance by pairing a December increase with a milder projected path of future increases. Most Fed officials believe it’s the cumulative thrust of policy, not any one rate decision, which ultimately matters for the economy.
The Fed’s rate-setting meetings are mapped out weeks ahead of time. Mr. Powell speaks with the other four Fed board members and all 12 Fed bank presidents in advance. The board’s staff circulates a proposed version of their policy statement together with two alternatives, outlining either a tighter or an easier stance.
The choreography typically helps smooth consensus-building among what can be an unwieldy crowd of policy makers. Some officials said it hurt the Fed in this instance because it made them less agile.
Financial markets tumbled in the days leading up to the December rate decision, and Mr. Trump repeatedly called on the Fed to stand pat hours before the meeting.
Priming markets to expect a rate increase “really put us in a box in this kind of situation. If you try to make changes on the fly, that’s always very difficult,” said St. Louis Fed President James Bullard.
Mr. Bullard and the presidents of Fed banks in Philadelphia and Minneapolis didn’t favor raising rates in December. Others, such as Dallas Fed President Robert Kaplan, were comfortable going ahead with a December increase but wanted to more directly signal a pause immediately thereafter.
Inside the Fed’s paneled conference room, Mr. Bullard reminded colleagues that in past periods of such volatility, including under longtime Fed leader Alan Greenspan, they would have delayed such an increase until the next meeting, scheduled for the end of January.
“That is a typical Greenspanian move,” he said. “I don’t think this committee is used to behaving that way.”
At Mr. Powell’s post-meeting press conference, his attempt to calm queasy markets failed. When he underscored that rates would rise less than anticipated previously, markets heard him say they would keep climbing.
Investors were also spooked after he said the Fed’s plan to shrink its balance sheet was “on autopilot.” The comment didn’t reveal new information but added to fears the Fed was on a predetermined path to tighten credit policy. Mr. Powell knew they hadn’t struck the right tone as soon as the press conference ended.
Over the following two weeks, credit and stock markets worsened. Mr. Trump fumed to his advisers about potentially replacing Mr. Powell, though administration officials later said the White House lacked the power to do so.
Presidents nominate Fed chairmen to a four-year term, subject to Senate confirmation. The law says Fed governors, who include the chairman, can be dismissed only “for cause,” which courts have interpreted to mean malfeasance or abuse of office.
When Mr. Powell returned from a family vacation in Florida after the holidays, he huddled with Fed Vice Chairman Richard Clarida and by phone with New York Fed President John Williams to discuss where policy needed to land by the time of their Jan. 29-30 meeting, and how to get there.
Mr. Powell used a previously scheduled on-stage interview on Friday, Jan. 4, alongside his two predecessors, Janet Yellen and Ben Bernanke, to unfurl the pivot to suspending further rate increases.
To avoid any miscues, Mr. Powell, who is at ease speaking off-the-cuff, responded to the opening question by reading from a piece of paper. Markets rallied.
Mr. Powell unveiled the shift without consulting with all of the reserve bank presidents. They supported him.
“Everybody realized pretty quickly that the communications needed adjusting” after the December financial-market swoon, said Chicago Fed President Charles Evans. “I give him high props for making that leadership choice to pivot.”
By March, most Fed officials were projecting no interest-rate increases in 2019.
And officials said that in six months, they would end the credit-tightening practice of allowing Fed-owned bonds to expire unreplaced.
Both of these were moves Mr. Trump had wanted a few months earlier.
The shift soothed markets, but not Mr. Trump. He said the Fed should cut short-term rates, and announced plans to name outspoken loyalists—and central bank critics—to the Fed’s board.
Mr. Trump called Mr. Powell on April 11 to talk about the need for lower rates. He reached the Fed leader around 9 p.m., just after Mr. Powell delivered remarks at the House Democrats’ annual retreat that defended the central bank’s independence.
Investors in futures markets began to place rising odds on a rate cut in the lead-up to the Fed’s most recent meeting, April 30-May 1.
Mr. Powell, in his press conference after the May meeting, pushed back against those expectations, when he described a recent inflation slowdown as temporary.
That confounded some investors because Fed officials, including Mr. Powell, have also signaled more alarm over why inflation isn’t rising more.
“There is a good deal of confusion about what the Fed is doing and why they’re doing it, and the Fed is responsible for some of that,” said Robert Brusca, who runs an economic consulting firm in New York.
Since Fed officials last met, the economic outlook has turned bleaker with the worsening of trade tensions with China. Bond markets turned more anxious after Mr. Trump’s unexpected decision to threaten tariffs on Mexico to secure tighter migration curbs.
Rising worry about a pullback in business sentiment and investment from a sustained conflict is giving the Fed new reason to consider rate cuts. Generally speaking, the Fed will want to move more quickly than it has in previous cycles to shore up growth at the first hint of any economic contraction because with its short-term benchmark at a historically low range of between 2.25% and 2.5%, it doesn’t have as much room to cut rates as in previous downturns.
The upshot is if the administration’s trade uncertainty harms the economy, the Fed may have little choice but to respond by cutting rates. “They can’t play political brinksmanship with the president,” said Ms. Coronado of MacroPolicy Perspectives.
On a recent trip through Asia, Peter Hooper, chief economist for Deutsche Bank Securities, said he was struck by questions from clients who assumed that the Fed had shifted its footing this year because of Mr. Trump’s pressure.
“People who know the Fed understand that’s not what’s going on, but the further you go from the US, the more you hear this,” said Mr. Hooper, a former Fed economist.
Even if some investors thought the Fed was acting politically by scrapping rate increases, there’s little evidence they believe this was a policy error. If they did, this should be reflected in bets on higher inflation, such as rising break-even rates derived from Treasury inflation-protected securities.
“That’s when you see people putting money where their mouth is,” said Narayana Kocherlakota, former president of the Minneapolis Fed.
Mr. Powell has told colleagues they could deal with presidential pestering by giving Mr. Trump what he wants—at tremendous cost to the institution’s hard-won credibility—or by reflexively doing the opposite, burnishing their independence in a foolhardy way that risks recession. The right course, he has said, is to make decisions based on their objective analysis of data—realizing that some calls may look like a concession to the president and others may look like a rebuke.
To tune out politics, Mr. Powell tells associates they must focus on “controlling the controllable,” borrowing a favorite phrase from George Sherman, the former Danaher Corp. chief executive. The two men worked together during Mr. Powell’s past career in private equity.
Presidents have long tried to influence the Fed. President Nixon pushed his longtime adviser, Fed Chairman Arthur Burns, to stimulate the economy ahead of the 1972 election. Inflation later accelerated.
President George H.W. Bush and his advisers frequently said the Fed kept too tight a grip on the money supply because of its preoccupation with inflation. Then-Chairman Alan Greenspan wasn’t swayed.
Over lunch last fall, Mr. Greenspan discussed with Mr. Powell the advice he offers anyone when asked about dealing with the White House: Wear ear muffs.
Since the 1990s, the Fed and central banks in other democracies have operated with greater political independence. Bank of Canada Governor Stephen Poloz carries around a fortune from a cookie at a Chinese-Thai restaurant in Ottawa that reads, “You are independent politically.” He keeps it in a plastic sleeve in his wallet.
Such institutional autonomy annoys Mr. Trump. He told advisers he is more concerned about the Fed’s rate increases hurting the economy than about any disruption from higher tariffs. In complaining that Mr. Powell lacks a “feel” for the markets, he likened him to a golfer who can’t putt.
Though Mr. Powell almost never refers to Mr. Trump by name, he has indicated to lawmakers and colleagues that he recognizes an important part of his four-year term will be to shield the institution from any political pressure.
“We’re never going to take political considerations into account or discuss them as part of our work,” Mr. Powell said at a January news conference. “We’re human. We make mistakes. But we’re not going to make mistakes of character or integrity.”
Mr. Powell, who began his career as a lawyer, has made clear to associates there aren’t any circumstances under which he would leave his job voluntarily, meaning a court battle would likely ensue should Mr. Trump try to remove him before his term expires in 2022.
People who suspect Mr. Powell will cave to Mr. Trump don’t know the man, said former Dallas Fed President Richard Fisher.
He cited, among other things, Mr. Powell’s wealth and his respected stature in Washington. Financial disclosures in 2017 showed Mr. Powell owned assets worth between $20 million and $55 million.
“He’s very comfortable in his own skin,” said Mr. Fisher. “You or I would probably be a little bit comfortable in our own skin if we had that.”
Source: The Wall Street Journal