Protection From The Fed “Put” May Be History
Back when Alan Greenspan was Fed Chair, from 1987-2006, he became known for the “Greenspan put”, by which the Fed would often respond to falling stock prices by lowering interest rates, including after the 1987 crash and the 2001 tech bubble burst. The “put” referred to a put option, and meant that the Fed would step in to try to protect markets from falling too far. Even after Greenspan’s departure, the “Fed put” continued, as Fed attempts to increase interest rates closer to historical norms stalled when confronted with equity market losses. In other words, Fed policy effectively reduced the risk of holding stocks, since the Fed would intervene or change policy if markets fell significantly.
As Noah Smith and Will Daniel each note, the extraordinary inflationary pressure of recent months appears to have brought a suspension, if not an end, to the Fed put, and markets have reacted accordingly. The Fed at this point is committing itself to curbing inflation; it is plausible that this commitment takes priority over cushioning markets. Between the scaling back of the Fed’s asset purchasing program and higher interest rates, there is less money bidding up available assets.
To express this idea another way, as Josh Barro observes, if the Fed successfully cools inflation by cooling the economy, equities are likely to fall in the interim. The larger question is how quickly and effectively the Fed will be able to bend the inflation curve. If the Russian invasion of Ukraine ends, supply chain snarls unfurl, and longer-term inflation expectations remain modest, the Fed may be able to normalize the Federal funds rate to the 3% range and then resume its dovish monetary policy regime. If inflation expectations become unanchored and the Fed needs to hike well above its 3% hope, then the Fed put may be kaput for years to come.
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