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Decoding Wall Street’s Rise: A Look Into the Fed’s Playbook

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Decoding Wall Street's Rise: A Look Into the Fed's Playbook
Wall Street’s all-time highs over the past few years have become so commonplace that they no longer command headlines anymore. Since the start of the year up to mid-October, the Dow Jones Industrial Average scaled 40 all-time highs, but you don’t see any mention of these records in the daily news.
Furthermore, every steep plunge is very quickly followed by a sharp rebound that more often than not takes the major indices to new record levels.
Where does this confidence come from that emboldens large numbers of investors to keep pumping money into a market that rose and continued to rise even as the US Federal Reserve raised interest rates 11 times between March 2022 and July 2023 from 0-0.25% to 5.25-5.5%?
Defenders of the bull market will undoubtedly point to the rise of artificial intelligence (AI) and the seemingly-unlimited potential it offers in terms of earnings as far as tech stocks are concerned.
For sure, the rise of AI has played a part, as has excess liquidity. A “soft landing” for the economy? Maybe. Much less discussed however, is a factor that has existed for so many years that it has now been taken for granted.
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It is the fabled “Fed put”, essentially an explicit promise by the US Federal Reserve to backstop any major market or economic collapse by cutting interest rates and expanding its balance sheet (or, if you prefer, print money) by as much as it takes.
Bloomberg news agency correctly identified this as a major factor in a May 2024 article when it said that the Fed put “has been a fact of life in markets for so long that people have become conditioned to act as if the central bank stands ready in its role as market saviour”.
“Put” is used because put options gain value in a falling market and are often bought to insure portfolios from sudden plunges.
Wall Street’s history of Fed put
It first appeared in 1987 when Fed chair Alan Greenspan slashed interest rates after the 19 October crash to prop up the stock market. It worked – but it also set the precedent for Fed intervention and bred the belief that the Fed would always intervene to ensure a quick recovery if ever the market crashed.
The second appearance came in 2001 when Greenspan lowered rates to one per cent after the 9/11 attack.
The third was in 2008 under chair Ben Bernanke in response to the US sub-prime crisis, one that ironically the Fed itself contributed to when it fell asleep at the regulatory wheel by allowing US banks to conceal worthless mortgages in complex instruments which were then sold to unsuspecting customers as “Minibonds’’ or “High-yield Notes”.
That crisis saw the Fed’s balance sheet expanding to about US$4 trillion which sent stocks soaring, but to appreciate how reliant the market became on being fed (pun intended) easy money, recall that an announcement in 2013 that the central bank would taper its pace of liquidity injections, known as “quantitative easing” or QE brought about a huge selloff in stocks and bonds, dubbed a “taper tantrum”.
Covid-19 came next, prompting current chair Jerome Powell to bring rates down to almost zero in 2020 and expand the central bank’s balance sheet to an eye-watering US$9 trillion.
The instruments the Fed used included the emergency lending facilities introduced during 2008’s US sub-prime crisis – the Term Asset-Backed Securities Loan Facility, the Commercial Paper Funding Facility, the Money Market Mutual Fund Liquidity Facility, the Primary Dealer Credit Facility, the Secondary Market Corporate Credit Facility and the Primary Market Corporate Credit Facility.
At the time, observers marvelled at the sheer size of the monetary injections, which were dubbed “QE infinity” because of an explicit promise to do whatever it took, even print an unlimited amount of money to prop up the economy and by extension, the market.
“Forget the bazooka, the Fed has gone nuclear” was one comment which nicely summed up the Fed’s reaction to Covid-19. Think about it – if officialdom has guaranteed to inject an infinite amount of money when the market is threatened, then there really is no real risk to worry about.
The systematic, market or undiversifiable risk that finance students are taught to factor in when investing in reality has been taken off the table, or at most, relegated to secondary importance.
As a side note: one has to wonder what might happen to local stocks if the authorities and central bank here were to provide a similar guarantee?
That aside, there should actually be no surprise that US stocks have risen in a virtual straight line even as rates were hurriedly raised in the latest tightening cycle to combat rising inflation.
Now that the Fed has declared victory over its battle against inflation, it has started lowering rates, the first being a 50-basis points reduction in September, and a cut of 25-basis point in November. This paves the way for US stocks to continue scaling new heights.
In theory, with the Fed “put” at the back of everyone’s minds, the sky is literally the limit.

Also read:

R. Sivanithy

From journalist to educator, he makes sense of dollars-and-cents issues.

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