It’s been the case the last few years that any kind of stock market investment was pretty much a no-lose bet. Since 2009, the S&P 500 index has grown sixfold, while the tech-heavy Nasdaq exchange has performed even better, rising 12-times during the same period too.
There are many reasons why the stock market’s sustained rally has persisted so long, but one of the key underpinnings has been the idea of the “Federal put”.
In addition to an already easy monetary environment – marked by ultra-low interest rates and abundant quantitative easing (QE) – the concept of the put stipulates that the US Federal Reserve (and, in practice, most other national central banks) will never permit markets to fall below a certain point – at least not before intervening with more QE and still lower rates.
The rationale for this is based on the premise that there’s so much debt locked-up in the global financial system, that to allow the markets to go into free-fall would trigger a chain reaction of instability that could prove almost impossible to reverse in the future.
The mechanism therefore takes its name from the options contract that traders use to insulate themselves from a fall in market prices, and is an example of a well-thought-out financial realpolitik in action.
However, the days of the Fed riding to the market’s rescue might well be coming to an end. The Nasdaq fell sharply at the start of April, on news that the Federal Reserve was actively contemplating ways to reverse the inflationary economic environment that’s prevailed over the last decade or so.
Minutes from the latest Federal Open Market Committee meeting were released to the public, and the general opinion seems to indicate that policymakers will take a decidedly hawkish approach to inflation here on out.
Why Is The Fed Acting Now?
The idea of the Fed put was first put into action by Alan Greenspan in the wake of the Black Monday crash of 1987.
The “Greenspan put” – as it’s sometimes known – resulted in a slashing of the federal funds rate, which had the intended effect of buoying investor sentiment when the markets suffered a downturn.
Greenspan used this strategy again in the early 2000s when the dotcom bubble eventually popped – as did his successor, Ben Bernanke, during the US subprime housing crisis of 2008.
Reduced rates – as well as an influx of cash from further quantitative easing – jolted financial institutions into lending more, which gave a boost to consumer spending and market trading alike.
However, the problem with using the put like this is that, as its assets and liabilities start to accumulate, the Fed’s balance sheet also expands accordingly. It reached a peak of about $4.5 trillion in 2014, having been relatively flat for many years at just $1 trillion.
The Fed did begin to tackle this after 2014, but had to reverse that process in 2018 when markets had their worst year since the Great Recession, with almost $7 trillion wiped off the price of stocks worldwide.
Despite the hiccup in 2018, the central bank again started unwinding QE in 2019, but had to halt those efforts when the overnight “repo” market spiked in September of that year.
It wasn’t long then until the onset of the pandemic, which triggered the Fed into a full-scale rescue mentality. This resulted in the most ambitious QE program ever seen, one that ultimately caused its balance sheet to swell to $9 trillion by the end of 2021.
The knock-on effect of all these rescue packages, and the Fed’s stymied plans to tackle them, has been that not only have stocks and bonds surged in price to record levels, but so too have other assets, including – most importantly – the critical housing and property market.
But now the Federal Reserve’s decided that this has to change, and the present moment is as good as any other. Indeed, even though the stock market is currently losing value, the economy is in great shape, having grown 6% in 2021 despite headwinds from the global pandemic. The labor market is also replete with higher wages and lots of new opportunities too.
That said, consumer confidence isn’t anywhere near as robust. Inflation is high, and prices have been rising at rates not seen since the beginning of the 1980s. The fear now is that market conditions could lead to a wage-price spiral, which could make inflation a stubbornly difficult problem to solve in the long-term.
What Did The Minutes Actually Say?
Because of these concerns, the Fed is finally determined to get things under control. Although the conclusion of the meeting in March wasn’t ratified by a formal vote, observers were inclined to believe that the policy stances outlined there were likely to be implemented in the future.
And despite those policy stances being fairly extensive, they were also relatively straightforward too. The central bank has decided to start offloading many of the assets it has accumulated over the years, and it’s settled on doing so at a rate of $95 billion per month.
This approach will mirror the way in which the Fed purchased the securities in the first place, with $60 billion of the monthly divestment coming from the repayment of Treasury bonds and notes, while the other $35 billion will come from the sale of mortgage-backed securities.
Furthermore, the Fed is also taking a more aggressive tone when it comes to the question of interest rates too. Comments emanating from the meeting suggest that the likelihood of Fed policy makers sticking with the conservative quarter point rate raise of the past look slim.
Indeed, bond market participants already anticipated such a move, factoring in a possible half point rise to their prospective balance sheets, with the latest prices in the short-term bond market also reflecting this position.
Taken as a whole, the minutes appear to indicate the Fed is ready and willing to take the fight to rising inflation, although not in as drastic a manner as some had initially feared.
Will The Federal Reserve Crash The Market?
Fortunately for investors, the probability of the Fed crashing the market is reassuringly low.
The measures outlined in the March committee meeting might ordinarily point to bad news for global stock exchanges, but the actual result could be far less damaging. In fact, shares soared during trading on the Wednesday that the Fed convened, indicating that Wall Street fears nothing from its conclusions.
High inflation is one of the market’s worst enemies, and, if the Fed can get a hold of it in time, it could actually be a net positive on the whole. A small draw-down now in market prices could save a larger one further down the line.
#1 Stock For The Next 7 Days
When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.
Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.
See The #1 Stock Now >>The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.