December 10, 2018
First, let’s explain exactly what a “Fed Put” is. A Fed put is defined as The confidence of Wall Street that the Fed will lower interest rates and print money to support the market until economic strength will be strong enough to carry stocks higher. The term “Put” is ascribed to this because a put option is basically a contract that offers a buyer protection from falling asset prices. It was first coined under the Chairmanship of Alan Greenspan when he lowered interest rates and printed money to rescue Wall Street from its 22% Black Monday crash back in 1987. The practice of bailing out stocks was institutionalized by Ben Bernanke, and then became a bonafide tradition perpetuated by Janet Yellen.
During the tenure of Ben Bernanke, the Fed Put took on new dimensions never before conceived. Such as a zero interest rate policy and the massive monetization of long-term Treasuries and Mortgage-backed Securities. The purpose of this strategy was to put a floor under asset prices and encourage the private sector to stop deleveraging. It was a total success. Wall Street’s mantra under Janet Yellen went something like this: The economy will soon improve and thus boost share prices. Or, if it does not, the Fed will keep interest rates at zero percent and force money down the throat of banks in the form of QE. With this, they will feel compelled to push a flood of new capital towards real estate, equities, and bonds, regardless of the underlying economic conditions.
And now, Wall Street believes that investors have received the latest iteration of a central-bank Put following Fed Chair Jerome Powell’s recent comments. Mr. Powell gave a speech on November 28th at the Economic Club of New York, in which the Main Stream Financial Media was quick to assess that the central bank is now on hold with its tightening of monetary policy.
That conclusion could not be more in error. It is what Wall Street wanted to hear, but that is not at all what came out of Jerome Powell’s mouth. The following was his direct quote: “Interest rates are still low by historical standards and they remain just below the range of estimates of that level that would be neutral for the economy.”
Powell’s statement was indeed meant to moderate his pronouncement on October 3rd that the Fed Funds Rate (FFR) was very far from neutral and that it could actually go above neutral for a period of time. But, by now stating that the FFR is just below a “the range of estimates” does not mean the Fed is near neutral. Rather, that there is a low, middle and high-end in the spectrum of estimates; and that the current rate is just below that range. That’s it.
However, Wall Street misinterpreted his statement as the Fed having achieved its neutral interest rate and is about to go on hold with further rate hikes. Nevertheless, the Jerome Powell Fed faces a much different dynamic than what both Bernanke and Yellen faced. Inflation targets have now been reached; whereas inflation was struggling to stay positive for much of tenure of the two previous Chairs. Not only this, but the FFR is not even half the level of where nominal GDP is currently—meaning it is extremely low by historical measures. And, asset prices are firmly back in bubble territory. Due to those asset bubbles and inflation rates, the Fed really has no choice but to raise the overnight lending rate for the 9th time during this cycle on December 19th. Otherwise, it risks long-term bonds spiking uncontrollably. The Fed also promises to hike 2-4 times next year.
Therefore, a more realistic Wall Street mantra at this time should be: the Fed will continue to slowly raise interest rates and burn $50 billion per month of bank credit, and will continue to do so unless or until the stock market or economy undergoes a significant decline. Hence, the Fed will only end its reverse QE process and stop raising rates ex-post; i.e., after the economy enters a recession, or in the wake of a stock market crash.
The truth is that the Fed is 180 degrees away from offering investors a genuine “Put” at this time, which would comprise the lowering of interest rates back to 0 percent and begin increasing its balance sheet through another iteration of QE. Therefore, the stock market is going to struggle due to a faltering economy, which will depress earnings and place further downward pressure on prices. Or, stocks will sink further into bear market territory because the Fed will continue to raise interest rates and make cash more competitive with equities—which still display extremely rich valuations historically.
Of course, there is no doubt that a Powell Put is coming. The Fed’s unbroken tradition since 1987 has been firmly inculcated into the current Keynesian regime. Nevertheless, the safety net below the equity market still remains a great distance below current valuations.