One major change that set the tone for the Federal Reserve’s interest rate hiking cycle of the last two years has been the widespread perception that it has abandoned the so-called “Fed put,” or the idea that the Fed would ease rates significantly if the equity market were to swoon suddenly.
The notion of the Fed put was conceived in the 1990s after then-Fed chairman Alan Greenspan lowered rates following financial crises in Asia, the collapse of Long Term Capital Management and the leadup to Y2K. Most notably, the Fed adopted extremely accommodative policies during extended periods after the bursting of the dot.com bubble, the great financial crisis and the pandemic. This easy monetary policy garnered widespread criticism from people who contended it penalized traditional savers, inflated certain asset prices like equities while fostering various distortions in the real economy. Some even blamed it for the dramatic expansion of income and wealth inequality.
In a note to clients over the weekend, market strategist Ed Yardeni saw signals that Federal Reserve Chairman Jerome Powell might be changing his tough-guy tune and reverting to the previous stance that he and his predecessors like Greenspan and Bernanke embraced. Yardeni noted that the central bank now expects higher GDP growth of 2.1% in 2024 rather than the 1.4% they anticipated back in December and higher inflation, 2.6% instead of 2.4%, as measured by PCE .
Yet they maintained their position that they’d cut rates three times in spite of a stronger economy. “In their collective opinion, Powell & Co. seem to agree that inflation is close enough to their 2.0% target that they should err on the side of easing to avert a recession, which has been a no-show since early 2022,” Yardeni wrote.
This morning Yardeni went much further and pointed to Powell’s numerous recent references to possible unexpected weakness in the labor market as justification for lowering interest rates. Powell “seems to be reassuring financial markets that the Fed has their backs,” he wrote. “We see that in his emphasis that labor market weakness—should it unexpectedly arise—could warrant monetary easing; inflation isn’t the only economic variable that could do so. His repeated mention of unexpected labor market weakness that would require a policy response, even while characterizing the labor market as robust with no sign of such weakness, seems to us code for: 'The Fed Put Is Back.'”
Yardeni’s conclusion was that if the Fed sees job growth moderate significantly without an accompanying decline in inflation, it still would “be likely to ease.”
Over the last two years, Yardeni has taken a different stance from many mainstream economists, most of whom have predicted a recession was imminent. Instead, he has argued that different sectors of the economy have experienced "a rolling recession," triggered in large part by structural lags like the travel bust and boom caused by the pandemic.
He has also maintained the wave of retirements among affluent baby boomers with fat 401k balances has stimulated the consumption side of the economy. If central bankers share that perspective, a serious stock market correction could short-circuit some of that spending.
In 2022 when the Fed began hiking interest rates, it appeared impervious to the decline in equity prices, as major indexes dropped more than 20%. Many market watchers hailed the death of the Fed put.
Back then, the economy was only two years into the post-pandemic recovery and in a more fragile place than it is today. That might prompt some to question the return of the Fed put at this time..