What is the Fed Put?
The Fed put refers to the price level in the financial markets in which the U.S. Federal Reserve will take accommodative actions that would boost financial markets. Actions taken commonly involve reversing interest rate hikes or restarting quantitative easing programs.
- The Fed put is a belief by financial market participants that the Federal Reserve will step in to boost the markets if the price of the markets falls to a certain level.
- Past instances of Fed puts occurred in 1987, 2010, 2016, and 2018.
- The Fed put is not a confirmed notion by the Federal Reserve themselves. As a result, there are no specific conditions that must be met for a Fed put.
Understanding the Fed Put
The U.S. Federal Reserve operates under a dual mandate from the U.S. Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” It generally involves:
- Setting accommodative monetary policies during a business cycle downturn to encourage consumer demand; and
- Setting restrictive monetary policies in a late business cycle to moderate inflation.
Although the Federal Reserve lacks a legislative mandate to support financial asset prices, it is accepted wisdom by the market participants that the Fed would step in should there be strong financial market distress. Such action is termed the “Fed put,” in which market participants believe there is a price level in the financial markets where the Federal Reserve will step in to support asset prices.
The Fed put is a play on the option term “put,” which acts as a form of insurance against losses:
Does the Fed Put Really Exist?
There are several occasions in the past when the Federal Reserve intervened in the wake of significant financial market distress. With that said, it should be noted that the Fed put is not a confirmed notion by the Federal Reserve themselves, but rather, a belief by financial market participants. As a result, there are no specific conditions that must be met to trigger a Fed put.
Below are some examples of Fed puts throughout history:
- In the Black Monday Crash of 1987 where the Dow Jones Industrial Average fell by 508 points (22.6%) due to hostilities in the Persian Gulf, fear of higher interest rates, and the introduction of electronic/program trading. The next day, the Fed intervened by affirming its readiness to serve as a source of liquidity to support the financial and economic system.
- During the 2008-2010 Global Financial Crisis, the Federal Reserve reduced interest rates and conducted quantitative easing. With the economy recovering, in June 2010, the Federal Reserve attempted to scale back monetary policy by bringing its quantitative easing program to a close. This, however, caused market jitters, causing the Federal Reserve to introduce a new quantitative easing program (called QE2) to soothe financial markets.
- In late 2015 and into early 2016, the value of stock prices globally sold off due to slowing growth in the Gross Domestic Product (GDP) of China, falling oil prices, the Greek debt default in 2015, a Brexit vote announcement, and implications of the effects of the end of quantitative easing in the United States in October 2014. In Q1 2016, the Federal Reserve directly invoked monetary tools to help prop the markets.
- In 2018, the Federal Reserve was raising interest rates and commencing quantitative tightening. The Fed’s actions were poorly received by the markets and even drew criticism from then-president Donald Trump. In 2018, the S&P 500 ended down 6.24%. As the markets continued to wane in mid-2019, Fed Chairman Jerome Powell provided large-scale repurchase agreements to U.S. investment banks to boost falling asset prices.
The Fed Put and its Impact on Market Expectations
The markets’ belief in the notion of the existence of a Fed put creates a moral hazard issue. It refers to the expectation that the Federal Reserve would bail out any significant decline in asset prices.
According to experts, this belief has spurred a high level of speculation in financial markets, which, in turn, have resulted in the 1998-2000 Internet bubble and the run-up in asset prices prior to the 2008 Global Financial Crisis.
A common term used in the financial markets is “don’t fight the Fed,” which implies not to sell or short assets as the Fed would come to the rescue. It has fueled the proliferation of dip buyers whenever financial markets face a significant drawdown in prices.
Will There Be a Fed Put in 2022?
As of March 2022, with the Federal Reserve poised to increase interest rates in 2022 to fight the highest reading of inflation recorded in recent history and geopolitical tensions stemming from Russia and Ukraine, U.S. financial markets have sold off considerably, with the S&P 500 and NASDAQ composite down nearly 9% and 15%, respectively, in the starting two months of 2022.
The recent market developments have spurred speculation that there will be a Fed put in the near term to boost markets if the market correction ensues. For example, in a survey conducted by Bank of America, respondents believe there will be a Fed put if the S&P 500 continues its descent to reach 3,700.
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