Markets fret over Fed approach under Powell

NEW YORK: Investors are starting to doubt whether they can count on the protective embrace of an accommodative United States central bank when markets go haywire.

Federal Reserve (Fed) chair Jerome Powell has said little about the sharp fall in Wall Street stocks this month, besides offering the platitude at his swearingin ceremony recently that “we will remain alert to any developing risks to financial stability”.

But the spotlight will be on the new Fed chair when he faces questions from both houses of the US Congress in semi-annual testimony starting tomorrow, and his audience will include investors who unceremoniously greeted his early tenure with one of the fastest 10 per cent falls in Wall Street stocks in history earlier this month.

“I don’t think it is a coincidence that this occurred at the same time as we saw the passing of the baton between two different Fed chairs,” said Kristina Hooper, global market strategist at Invesco Ltd, an asset management company, adding that former Fed chair Janet Yellen had “lulled” markets into complacency.

Powell could be very different from Yellen, she said.

The notion that the Fed would always be there to prop up shellshocked markets prompted the notion of a Fed “put” option under three prior Fed leaders Yellen, Ben Bernanke and Alan Greenspan. The term is a reference to the hedging strategy of using a put option to guarantee an investor a sale at a preset price to limit losses.

While the Fed did not buy stocks or sell options in response to the 2007-2009 financial crisis, it did push short-term interest rates to historic lows and bought bonds, driving down yields.

Starved for yield in recent years, investors were forced into the stock market, driving up equity valuations, thanks to the Fed’s policies.

“There was definitely a Yellen put, and it remains to be seen whether there will be a Powell put,” said Hooper.

Yellen’s Fed did later raise interest rates though, starting in late 2015, but it did so more slowly than in earlier cycles and it backed off when markets were stressed. In 2015 and 2016, the rate-setting Federal Open Market Committee (FOMC) delivered just one rate hike per year.

The Fed now faces pressure to move more quickly to guard against a possible overheating of the economy, as the Fed’s balance sheet and global interest rates still bear the tidemarks of emergency policies.

Higher interest rates could lure cash out of the stock market and into bonds as yields rise. Higher rates could also tighten credit for consumers as well as companies that have struggled to grow their sales as quickly as their profits during this economic recovery.

Some investors have even argued that the Fed’s desire to avoid tripping up markets risks the central bank moving too late to prevent a rise in inflation and a market bubble. The argue that an economy that is overheating would require potentially destabilising interest rate hikes later.

The Fed needed to slow the economy down a bit for its own good, as so far the Fed’s efforts at tightening financial conditions had not been successful, said Tony Crescenzi, market strategist and portfolio manager at Pacific Investment Management Co.

“Market participants would rather see the Fed take actions that sustain the expansion, and that means more rate hikes,” said Crescenzi.

It is unlikely the Fed would “view a dip in the stock market — especially the one that was seen recently — as a reason to come to its rescue,” he said.