Not much help for markets from the Fed

Jerome Powell is unfazed by the sharp fall in Wall Street stocks this month

INVESTORS are starting to doubt whether they can count on the protective embrace of an accommodative US central bank when markets go haywire.

Federal Reserve chairperson Jerome Powell has said little about the sharp fall in Wall Street stocks this month, besides offering the platitude at his swearing-in ceremony last week that “we will remain alert to any developing risks to financial stability.”

But the spotlight will be on the new Fed chairperson next week 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 percent 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, an asset management company, adding that former Fed chairperson 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 shell-shocked markets prompted the notion of a Fed “put” option under three prior Fed leaders – Janet 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 shortterm 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 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.

The minutes of the Fed’s FOMC meeting on January 3031, published on Wednesday, showed policymakers expressing the need to keep raising interest rates, most believing that inflation will rise further.

On Friday, the Fed’s semi-annual monetary policy report to Congress, its first under Powell, said the Fed sees steady growth continuing and no serious risks on the horizon that might make the central bank pause its planned pace of rate hikes.

“The economic expansion continues to be supported by steady job gains, rising household wealth, favourable consumer sentiment, strong economic growth abroad, and accommodative financial conditions,” the report said.

“This will be one of the more hawkish Feds we have experienced in 20 years,” said Andrew Brenner, head of international fixed income at NatAlliance Securities, a broker-dealer.

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. – Reuters