Monthly fixed-income focus

Federal Reserve set to pause as DOJ investigates Powell, new Chair to be announced

Key Takeaways

• The Fed is widely expected to hold rates steady at its January meeting as a stabilizing labor market gives officials time to look for further signs that inflationary pressures continue to ease.
• A new Fed Chair will be appointed to replace Jerome Powell, whose term ends in May. Leading candidates include National Economic Council Director Kevin Hassett and former Fed Board member Kevin Warsh.
• The U.S. Department of Justice opened an investigation of Chair Powell's testimony to the Senate Banking Committee regarding renovations to Federal Reserve office buildings.
• The U.S. Supreme Court will hear oral arguments later this month on the attempted removal of Fed Board member Lisa Cook.

Fed policy outlook: January pause likely

After three consecutive rate cuts in late 2025, Fed appears poised to adopt a more patient stance. The recent decline in the unemployment rate to 4.4% affords policymakers time to monitor further signs that inflation continues to slow toward the 2% target. With the federal funds target range at 3.5%-3.75%, monetary policy is now close to neutral, in our view. The Fed's preferred inflation gauge — personal consumption expenditure (PCE) inflation — is running at 2.8% annualized¹. A neutral policy rate is generally considered to be roughly 0.75%‒1% above inflation².

Given inflation remains above target, we expect the Fed to pause for at least a few months before considering additional cuts. A labor market characterized by slow hiring and modest layoffs should keep the Fed on track for one or two more rate cuts later this year, assuming inflation continues to moderate. As shown in the chart below, bond markets are pricing in expectations for a slightly faster pace of easing, compared with the Fed's own projections:

Next Fed Chair: Hassett vs. Warsh

President Trump will soon announce a successor to Jerome Powell, whose term will end in May 2026.

• Kevin Hassett, National Economic Council Director and former Fed economist, is widely viewed as a more dovish option. Based on his prior commentary, he would likely favor quicker and deeper rate cuts.
• Kevin Warsh, Fed Board member from 2006-2011, has advocated for a smaller Fed balance sheet — consistent with tighter monetary policy — although his historical voting record on rates was relatively dovish. He brings credibility and experience that includes helping steer the Fed through the 2008 Financial Crisis.

While the choice remains uncertain, either candidate would likely reflect a dovish shift for the high-visibility Chair role. Importantly, the Chair's influence is tempered by the Fed's institutional design to preserve independence from political pressure, including staggered 14-year terms for Board members and independent board appointments for regional Fed presidents³. All voting members maintain equal votes and routinely express independent views. While some members may show some deference to the Chair, several officials have recently reiterated the importance of central bank independence.

Department of Justice investigates Fed Chair

On January 11, the U.S. Department of Justice announced an investigation of Chair Powell's testimony to the Senate Banking Committee concerning renovations to Federal Reserve headquarters. The project has experienced cost overruns and delays tied to construction challenges — such as abatement of lead, asbestos and groundwater — as well as local ordinances requiring an underground parking garage.

In a video statement, Powell said the Department of Justice has served the Federal Reserve with subpoenas (court order requesting evidence) and threatened criminal indictments³. He noted that the Fed has sought to keep Congress informed about the project and stated he intends to remain in his role, citing the need for public servants to stand firm in the face of threats at times³.

This investigation could be a precursor to an attempt to remove Powell from the Fed. Under the Federal Reserve Act, the President may remove Fed Board members only "for cause"³, a term not explicitly defined but historically interpreted by courts to mean neglect of duty or malfeasance (wrongdoing or misconduct by a public official).

In our view, a conviction may be required to establish cause, as it would demonstrate the facts of the case were adjudicated by a court, while affording Powell due process under the U.S. Constitution. Moreover, any effort to remove him would likely face significant legal challenges, a process that would take time.

Supreme Court to hear case on Lisa Cook

On January 21, the U.S. Supreme Court is scheduled to hear oral arguments regarding President Trump's attempted removal of Fed Board member Lisa Cook over allegations of mortgage fraud prior to her appointment. The Court temporarily blocked her removal pending further review.

We expect the Supreme Court to allow Cook to remain on the Board. She has not been formally charged, and the alleged actions predate her tenure. As with Powell, a conviction may be needed to establish cause for removal.

If the Court were to permit Cook's removal based on allegations alone, the Fed's independence could be called into question. Such a precedent could expose other Fed officials to political pressure. Markets might respond by pricing in higher inflation expectations, potentially lifting intermediate- to long-term yields, steepening the yield curve, and pressuring bond prices.

<sup>Sources:
1. FactSet
2. Federal Reserve Bank of New York
3. U.S Federal Reserve</sup>