The Federal Reserve has faced some harsh criticism for its interest rate hikes in recent quarters. In the past, stock market investors have taken comfort in the idea of a “Fed put” that supports stock prices, or at least does them no harm. Here’s a closer look at what exactly the Fed put is, and whether it’s still helping investors.
What Is The Fed Put?
The Fed put is the general idea that the Federal Reserve is willing and able to adjust monetary policy in a way that is bullish for the stock market.
The Fed’s primary goals are related to maximizing employment and keeping inflation in check. Yet a stable economy, modest inflation and the stock market are all closely linked. If employment crashes, inflation gets out of control or the stock market plummets, the Fed will not be serving its purpose of stabilizing the economy.
According to daytrading.com, the idea of the Fed put originated with former Fed Chair Alan Greenspan in the 1990s. Greenspan famously cut interest rates in response to the 1998 stock market sell-off following the collapse of Long-Term Capital Management.
Fed Put In Action
There are two ways to look at the idea of a Fed put.
First is the idea that the Fed would step in to support the market with interest rate cuts and other accommodative policies in the event of a market downturn. In addition, when stock prices have bullish momentum, the Fed put also suggests the Federal Reserve will try not to do anything to disrupt that momentum.
The second scenario has been the most relevant for investors in 2018. The Fed recently issued its third interest rate hike of the year, yet the SPDR S&P 500 ETF Trust SPY is up 9.6 percent year-to-date.
The Fed Put Today
During the Fed’s recent press conference, Chair Jerome Powell said the stock market is very much on his radar.
“He mentioned the linkage between equity prices and economic stability twice, and with the same basic equity-friendly message,” DataTrek Research co-founder Nicholas Colas recently said.
“There is still a 'Fed put.' This is the idea that the U.S. central bank sees stock market stability as important to its mandates of full employment and moderate inflation.”
For now, at least, it still seems as if the Fed has investors’ backs. The big test of the Fed put could potentially come if the stock market suffers a steep correction in coming months that could put pressure on the Fed to dial back or suspend its schedule of interest rate hikes.
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