Monetary policy: read article and explain the relation between fed
put, interest rates, fed balance sheet shrinking, and bond and
stock prices and yields. Just explain the article
Does Jay Powell Have the Stock Market’s Back?
Investors have long expected the Fed to step in when prices plunge.
It looks like the current chairman won’t let them down.
By Michael P. Regan
Business Week; February 8, 2019, 4:00 AM CST
Traders and stock market pundits are talking about a “Powell put,”
after Federal Reserve Chairman Jerome Powell presided over a
decision in late January to ease off on rate hikes. It’s a callback
to the fabled Greenspan put, which was the idea that Fed chief Alan
Greenspan in the 1990s and early 2000s would never allow the stock
market to fall too far.
Worth decoding is the Wall Street jargon: A put is a trade that
pays off when shares fall. Investors can use it as a kind of
insurance. But if you expect the central bank to step in and ease
monetary conditions whenever the market gets anxious, that’s almost
as good a safety net. Hence the notion of the Fed providing every
investor with a put.
The reality, of course, is more complicated. Greenspan’s aggressive
interest-rate cuts didn’t prevent the dot-com bubble from bursting,
and Ben Bernanke’s reductions couldn’t stop a tailspin as the
financial crisis unfolded. Still, both arguably helped fuel a
recovery once stocks bottomed out. In the Janet Yellen era, pauses
between hikes rather than cuts were what some called the Yellen
put.
The drama surrounding Powell is that traders can’t quite figure out
how low he’ll let the market go. From the start he’s shown some
tolerance for stock market pain. He assumed the job a year ago as
the economy was accelerating. The S&P 500 had surged 24 percent
in the 12 months through January 2018. But it was amid a 10 percent
retreat that Powell took the oath of office in early February. In
remarks at his swearing-in ceremony, he said, “We are in the
process of gradually normalizing both interest-rate policy and our
balance sheet.” Traders took that to mean Powell wasn’t in a hurry
to help them out.
It didn’t matter for long, because the market recovered as
President Trump’s tax cuts fueled a surge in earnings, even as the
Fed went on to raise its benchmark rate in March, June, and
September. But after the third hike, which brought the upper end of
the federal funds rate to an almost 11-year high of 2.25 percent,
stocks started swooning. The S&P 500 was down about 13 percent
from its record as the Fed met in December. Even that didn’t
produce a Powell put: The central bank lifted borrowing costs a
fourth time, and its Dec. 19 statement indicated that “some further
gradual increases” in rates were ahead. The market went on to
extend its fall to almost 20 percent from its record high before
paring those losses.
Then came the January surprise. The Fed kept rates unchanged—as
expected—but made a crucial tweak in its language, eliminating
reference to further rate hikes. It also issued a statement
regarding its strategy of shrinking its $4 trillion balance sheet:
letting bonds in its portfolio mature without replacing them, which
can put upward pressure on interest rates. The pace of this
downsizing, which Powell previously said was on “autopilot,” was
now being reconsidered. Asked about the role the stock market
played in his change of heart, he pointed at the ripple effects on
the broader economy. “Financial conditions matter,” he said at a
press conference following the announcement. “Broad financial
conditions changing over a sustained period, that has implications
for the macro economy.”
Wall Street’s Fed watchers reacted in shock. Barclays Plc economist
Michael Gapen called it “capitulation” in the face of a volatile
market. George Saravelos, head of foreign exchange research at
Deutsche Bank AG, referred to “regime change.” Tom di Galoma at
Seaport Global Holdings LLC called it “one of the most dovish
turnarounds” he’s seen in his 30-year career. Short-term
interest-rate traders started betting more on rate cuts than rate
increases.
Investors shouldn’t get carried away. “The market tends to hear
what it wants to, rather than what is really being said,” wrote
Brad McMillan, chief investment officer for Commonwealth Financial
Network, a group of broker-dealers and advisers. “So far, what the
Fed has said is that it is being patient with rates and intends to
keep them as the primary tool of monetary policy. It did not say
that policy will be loosening.”
The question now is what happens if stocks keep climbing and
economic data strengthen enough to threaten one of the Fed’s main
mandates, keeping inflation in check. Given Powell’s commitment to
normalization, some think his put looks like it’s part of a more
elaborate trade known as a “collar.” That’s a bet that the market
will stay in a certain range. “We’ve shifted from a Fed put to a
Fed collar,” Michael Collins, a senior portfolio manager at PGIM
Fixed Income, told Bloomberg Television on Feb. 1. If stocks rally
until the central bank’s next meeting in March, he worries the Fed
will be “talking about another hike or two later this year. And
maybe that limits the upside.”
BOTTOM LINE - Fed Chairman Powell started a course of raising rates
despite jittery markets last year, but he now seems hesitant to
spook investors with further hikes.