ROI-'Battle for the Fed' heats up to challenge rate horizon: Mike Dolan

By Mike Dolan

LONDON, Jan 26 (Reuters) - The battle for Federal Reserve independence has already gone up several gears this year, yet the central bank is showing little sign of capitulation - and now it has support from the Supreme Court and senior politicians.

Whether that has emboldened the Fed to push back hard on pressure for faster rate cuts will be the key test this week.

Clearly angered by this month's threat of a criminal case against him over Fed building renovations, outgoing Fed Chair Jerome Powell has sharpened his tone on Fed independence, calling the Trump administration's attack on him a mere "pretext" to pressure the Fed into ?deeper interest rate cuts.

An acceleration of easing almost certainly won't begin at this week's Federal Open Market Committee (FOMC) meeting. But how Powell maps out the policy path going forward and addresses questions about political pressure may be the main takeaway - especially with a real chance U.S. ?President Donald Trump announces his pick to replace Powell as the two-day gathering unfolds.

It's the first Fed policy decision of the year on Wednesday, with little or no market speculation that ?the bank will lower borrowing costs again so soon in 2026.

After three additional rate cuts late last year, another pause is widely expected. Brisk ?growth, still above target inflation, stable unemployment, buoyant financial ?markets and loose overall financial conditions all underscore the case for holding steady.

With many Fed policymakers assuming the central bank is at or close to a neutral policy setting, the arguments for it to start stimulating the economy right now are thin - not ?least with fiscal policy jets kicking in this year and lingering uncertainty around the price impact of tariff ?rises.

The median view of Fed policymakers last month was that just one more rate cut was likely in 2026. And despite the political noise, financial markets - which had started the year betting on two cuts - are slowly starting to chime with that view. Futures have pared back their full-year easing tally to just 44 ?basis points - with another cut not fully priced until July.

That's far from the deep cuts ?demanded by Trump or the ?150 bps of additional cuts this year called for by Trump's latest appointee to the Fed board - his former economic adviser Stephen Miran.

REACTION FUNCTION

All of which raises the persistent question about why concerns about a new Trump chair or further administration appointees to the board have not seen rate futures markets reprice more dramatically. After all, possible vacancies ?may emerge if the embattled Fed Governor Lisa Cook is eventually forced out or indeed if Powell stands down from the board when his term as chair ends in May.

But as it stands, markets still don't see the current 3.62% Fed policy rate getting below 3.2% through the end of 2027.

The heat of GDP growth and ebbing worries about a big fracture in the labor market remain the big factors - although Trump's team also sees these and concludes faster cuts are required regardless.

However, the calm market picture was underscored by the Supreme Court hearings on the Cook case last week, where justices repeatedly warned about damaging Fed independence if she was fired while still defending a legal case against her.

Even conservative Justice Brett Kavanaugh said that such a low bar for the president to ?remove her would "weaken, ?if not shatter, the independence of the Federal Reserve."

Significantly in an election year, some Republicans in Congress are also balking at the risks to Fed independence of the possible criminal case against Powell.

Powell now takes center stage this week with his new, outspoken take on independence - a stance that may even stoke speculation about him refusing to stand ?down from the board in May. That would be within his rights, because his regular board term lasts until 2028, though it would be unusual for an outgoing chair.

All of this supports an argument in markets that the political pressure won't change the existing approach of the Fed any time soon and that only a major shift in the economic picture will warrant that. Curiously, market easing bets only pick up again when Powell's term on the board ends in January 2028.

Writing before the Cook hearings last week, Morgan Stanley's Chief Global Economist Seth Carpenter said that, short of a Supreme Court ruling that allowed Trump to make wholesale changes at the board, the Fed's "reaction function" was unlikely to change abruptly or materially.

But he added that "we should not lose focus on the importance of a new Fed chair".

"The bigger question is how a new Fed chair steers the Committee when the economic ?data are much more difficult to read, especially if strong growth continues with tepid labor markets."

Rarely has a Fed meeting decision taken such a back seat to the machinations around the future of the institution itself.

The opinions expressed here are those of the author, a columnist for Reuters.

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(by Mike Dolan; Editing by Marguerita Choy)