Traders and Trump May Wait in Vain for Fed to Execute 'Powell Put'
Federal Reserve Chairman Jerome Powell, like former Chairs Alan Greenspan, Ben Bernanke and Janet Yellen, now has his own "put."

The Federal Reserve feels your pain. Just don't expect more than sympathy. 

The Standard & Poor's 500 Index of large U.S. stocks has tumbled 8.4% in the past month alone, wiping out gains for the entire year, as investors fret over everything from rapidly rising interest rates to a prolonged trade war with China. That's despite a U.S. economy that looks healthy: Gross domestic product grew at a robust 3.5% pace in the third quarter, and the unemployment rate is currently at 3.7%, the lowest since the first year of Richard Nixon's presidency in 1969. 

And as often happens when the stock market swoons, a time-worn discussion has resurfaced: Will the Fed bail out investors by halting its push to raise U.S. interest rates, or even cutting them?

The short answer, according to Bank of America Merrill Lynch Global Economist Ethan Harris, is no -- or at least not anytime soon. The rationale is that when Fed officials raise interest rates, as they have been doing now since late 2015, they expect investors to correct accordingly. After all, higher interest rates serve as a brake on the economy by boosting borrowing costs for households and businesses.  

"From the Fed's perspective, the recent correction is par for the course," Harris wrote in a report on Friday, Oct. 26. "We think the markets will have to find a floor without Fed help." 

For free-marketeers, the notion of a Fed bailout is noxious: Wall Street traders who are all too glad to pocket gains when markets are buoyant shouldn't get free downside protection from a steep price drop, courtesy of the central bank.

There's even a cynical cliché to describe the phenomenon, borrowed from the arcana of options trading: it's called the Federal Reserve chair's "put."

A put option gives the buyer the right, but not the obligation, to sell a security at a specified price; in many cases, put options are used as a hedge, giving the investor a quick way out of a trading position at a guaranteed exit price in the event of a market plunge.

So in the 1990s, traders and economists coined the "Greenspan put" to refer casually to the belief that former Fed Chairman Alan Greenspan would cut interest rates to save the stock market if it dove too deeply. For investors, the Fed's readiness would work like a free put option -- automatically providing downside protection for their portfolios.

In the ensuing years, speculation surfaced of the "Bernanke put" and the "Yellen put," eponymously trailing former Fed chairs Ben Bernanke and Janet Yellen. And lately, there's growing talk the "Powell put" -- after current Fed Chair Jerome Powell.

According to the German lender Deutsche Bank, Fed officials aren't entirely blind to stock-market volatility. That's partly because so much of Americans' wealth is tied up in stocks, so a big move downward can affect the broader economy. A market correction also can hurt confidence, prompting consumers and businesses to delay big purchases and investments until stocks rebound. 

"The question is how big of a move is needed for the Fed to pay attention," Deutsche Bank Senior Economist Matthew Luzzetti wrote in a report on Oct. 11. "In other words, where is the Powell put currently?"

At the time, Luzzetti estimated that the stock market would have to fall by another 10%. That would imply a level of 2,455 for the S&P 500 -- another 7.7% move down from current levels. 

The Fed's indifference to stock investors' pain was underscored on Oct. 10 by Raphael Bostic, president of the central bank's Atlanta branch: "I won't let a stock market move on its own reshape my view of the economy," he said, according to Bloomberg News. 

Analysts at the investment bank Morgan Stanley wrote Sunday in a report that there's a "high bar for the Fed to turn more dovish." Dovish is economist-speak for central-bank lenience, when officials keep interest rates low under the belief that inflation is in check.  

In the aftermath of the financial crisis of 2008, the Fed cut interest rates to near zero to help markets and the economy recover. And rates were kept close to zero for several years. 

Over the past three years, though, the Fed has boosted rates to a range between 2% and 2.25%, under the argument that doing so will keep the economy from overheating and prevent inflation from spiraling out of control. Higher rates act as a brake on investment and therefore growth, since they usually push up borrowing costs for consumers and businesses, via mortgages, credit cards and corporate loans; in turn, such an economic slowdown typically reduces upward pressure on consumer prices.

Indeed, President Donald Trump, who claimed credit for the stock market's performance when it was going up, has blamed the Fed recently for the market's descent -- saying that the central bank is raising rates too fast. 

But according to Harris at Bank of America Merrill Lynch, the Fed's current rate-hiking cycle -- with roughly a 0.25 percentage point hike every three months --  is proceeding at "half speed" in comparison with prior eras. Which puts the Powell put even further away. 

"Economic and financial fundamentals are too positive for the Fed to slow an already half-speed hiking cycle." Harris said. 

Luzzetti, of Deutsche Bank, says that a 16% plunge in stocks would "tighten financial conditions" by roughly the same degree as a 0.3 percentage-point rate increase by the Fed. In other words, if stocks fell that steeply, the central bank could avoid another 0.25-point hike.   

But that's still a ways off, Luzzetti wrote: "The Powell put remains significantly out of the money."

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