How the Supreme Court Could End This Bull Market

In its latest move, the U.S. Supreme Court upheld the president’s termination of Democratic Federal Trade Commissioner Rebecca Slaughter. (Chip Somodevilla/Getty Images)

About the author: Christopher Smart is managing partner of the Arbroath Group, an investment strategy consultancy, and was a senior economic policy advisor in the Obama administration.

The biggest risk for Wall Street today isn’t a potential recession or a tech earnings bust. It is the Supreme Court, which has been asked to issue rulings with the reach to reshape the U.S. economy, from interest rates and budgets to regulations and tariffs.

That so many crucial economic decisions land in court indicates the country’s rising political dysfunction. The more economic policy that is determined by constitutional theory rather than sound economics, the more it will spook investors who are already struggling to forecast growth and interest rates.

Supreme Court decisions have occasionally moved markets in isolated matters in recent years. Healthcare stocks rose following a 2012 ruling in favor of individual mandates in the Affordable Care Act. Online retailers took a hit from a 2018 decision that required them to collect sales taxes.

But it has been nearly a century since the justices have had such decisive influence over the country’s macroeconomic future. In the depths of the Great Depression, the court ruled repeatedly against President Franklin Roosevelt’s reflationary efforts to raise prices and stabilize wages. But it backed later elements of the New Deal once economic recovery took root.

The court’s most dramatic decision came in 1935, when it supported the government’s decision to abrogate gold clauses in corporate and Treasury bonds. The clauses allowed bondholders to choose interest payments in gold coin or its equivalent value in gold to protect them from depreciating currencies. But surging gold prices would have bankrupted the country all over again had just one justice flipped the 5-4 ruling in favor of the Roosevelt administration. Stocks spiked and bond yields fell.

Today, the court’s docket addresses the full range of policy tools to reshape the economy.

The Trump administration’s case against Lisa Cook, the Federal Reserve Board governor, is ostensibly about alleged discrepancies in her mortgage applications. But the real issue at stake is the extent of the president’s influence over the people who are meant to set interest rates independently.

Purists argue there is no such thing as true Fed independence, given its coordination with the Treasury Department. But economists who rarely agree on anything mostly concur that setting interest rates with the next election in mind leads to hyperinflationary outcomes like those seen in Turkey and Argentina. A ruling for the administration would surely send rates higher as markets question the Fed’s commitment to fighting inflation.

The court will also get the chance to weigh in on fiscal policy in a lawsuit over the administration’s refusal to spend $4.9 billion of congressionally appropriated funds for foreign aid. Under the 1974 Impoundment Control Act, Congress has 45 days to approve a request to cancel funding. But President Donald Trump notified House Speaker Mike Johnson on Aug. 28 that he wouldn’t be spending the money, effectively short-circuiting any legislative response before the end of the fiscal year on Sept. 30.

Chief Justice John Roberts has allowed the money to remain unspent for now. It is possible that markets could reward this small step toward greater fiscal discipline with slightly lower rates, but a Supreme Court victory for the administration in this case would also dramatically shift fiscal power away from Congress—with unpredictable consequences.

Court rulings on regulatory policy could have significant effects on corporate profits. This week, the court backed the president’s right to remove an independent regulator. That could advance the administration’s efforts to cut red tape. Pending cases involving more lax enforcement of environmental laws are set to also reduce regulatory costs.

But any relief from deregulation could be a wash. The court is also due to rule on the administration’s efforts to crack down on undocumented immigrants. If Trump is successful, the country’s labor supply could shrink, driving up labor costs.

The most disruptive looming decision, however, centers on tariffs and the president’s use of the International Emergency Economic Powers Act. Passed in 1974, the law has been the basis for escalating waves of sanctions against Iran, Russia, and others—but it doesn’t actually mention tariffs as a policy tool. Opponents also argue that a trade deficit doesn’t meet the bar of an emergency.

If the court reverses the IEEPA tariffs, Trump will likely try to reinstate tariffs through other avenues. But it would still trigger substantial confusion. Importers would scramble to make sense of the shifting rules and demand refunds for the tens of billions of dollars in tariffs they have already paid to the Treasury. Stocks would sell off to price in the chaos, while bond yields would rise to reflect a widening budget deficit.

The careful investor, therefore, will keep a keen eye on court headlines in the months ahead. Any one of these decisions could drive markets higher or lower, but the investment case for USA Inc. could unravel substantially if the country’s economic trajectory has drifted into the control of its lawyers and judges.

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.