24 Dec COTW: The Powell Put
The “Fed put” is a term that describes the view held by many market participants that the Fed is generally willing and able to adjust monetary policy in a way that is bullish for stocks. Over the last 25 years, the Federal Open Market Committee (FOMC) has raised interest rates 40 times. The hike last week was particularly interesting as it comes at a unique time for equities. The FOMC has never raised interest rates when the S&P 500 has experienced a significant drawdown from the previous rate move. The drawdown at the time of the last rate hike was almost 3x larger than any other pre-hike drawdown in the last 25 years.
The chart below shows the cumulative price performance of the S&P 500 starting the day after an FOMC rate move and concluding the day before a subsequent rate increase. Only 10 of the 40 interest rate hikes shown have been in the context of declining equity markets, with all those declines being much more benign (less than 5%) than the current one. This makes intuitive sense: the FOMC typically tightens financial conditions during economic expansions that should generally occur alongside a positive backdrop for equity markets.
In this week’s chart, we have highlighted select policy moves to provide context for when the rate hikes occurred and to demonstrate that FOMC tightening cycles have typically led to market turmoil. For instance, the FOMC raised interest rates six times (total of 175 basis points) in eleven months leading up to the Tech Bubble bursting in 2000. Similarly, from 2004 to 2006 the FOMC raised seventeen times (total of 425 basis points) prior to the Credit Crisis in 2008.
This interest rate cycle has seen nine explicit increases (total of 225 basis points), although the implicit impact on the economy may be higher. In addition to rising interest rates, we believe equity markets have been challenged recently by the continued reversal of another monetary policy tool, quantitative easing to quantitative tightening, whereby the FOMC shrinks it balance sheet. Starting in October, the balance sheet began to decline by $50 billion per month. The FOMC may pause after this hike and pursue closer to two rate increase in 2019 (which is currently expected by the FOMC’s dot plot), but they continue to tighten liquidity via their balance sheet. This dynamic should continue to be watched closely.
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