The ‘Fed Put’ – Gone Until There’s Blood in the Streets

Published on January 30, 2022

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Stephen Flood
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The ‘Fed put’ – gone until there’s blood in the streets

Well, it’s happening. Bitcoin (and other cryptocurrencies are sharply down, along with equity markets in many advanced economies.

And the Federal Reserve (the U.S. Central Bank) statement and press conference on Wednesday didn’t indicate any backing down from raising interest rates, maybe as soon as the March meeting.

The Fed’s stance pivot from ‘the economy needs additional stimulus’ to ‘it is time to start tightening policy’ came at the end of 2021 when Fed officials changed their view that 40-year high readings on consumer price inflation was due to transitory factors and will subside on its own.

Their new stance that high inflation is permanent and is what ensures tighter policy. The Fed has already started reducing how much it is adding to its balance sheet each month with another reduction at Wednesday’s meeting to purchasing a total of US$30 billion in assets in February 2022, from a high of US $120 billion in assets being added to its balance sheet each month.

The Fed will likely end these purchases altogether at its next meeting, scheduled for March 15-16.

And is indicating that it will raise interest rates at that meeting too.

The market implied probability currently has a 100% likelihood of a March interest rate hike.

The Federal Reserve is also discussing the possibility of starting to reduce its bloated US$9 trillion balance sheet soon after.

Two points we want to address below – the Fed ‘put’ and the decline in bitcoin.

What is a Fed ‘Put’?

The term was first used in the 1980s when Alan Greenspan was Fed Chair. Investopedia (with our bolding added) defines it as:

Greenspan put was the moniker given to the policies implemented by Alan Greenspan during his tenure as Federal Reserve (Fed) Chair.

The Greenspan-led Fed was extremely proactive in halting excessive stock market declines, acting as a form of insurance against losses, similar to a regular put option

… A historical review of the price action after each instance of the Greenspan put lends credence to the market belief that the Fed would continue to back-stop the stock markets in the future.

Since Greenspan, every Fed Chair has exercised their own version of what has now been coined the ‘Fed put’.

This ‘put’ jargon means the Fed has backed off from tightening policy when equity markets decline significantly.

The Fed (and other central banks) care about equity markets because they are a leading indicator of economic activity. Recessions and recessions lead to layoffs and slack in labour markets associate with sharp declines.

And remember the Fed has a dual mandate of ‘price stability and maximum sustainable employment’.

January 2022’s big change is that the Fed put has been cancelled because central banks think stopping inflation matters more than keeping stock markets near all time highs.

The message that the Fed’s focus is on bringing down the high inflation numbers came through this week’s meeting statement. Also, equity markets continued to decline as did bitcoin.

We are still skeptical that the ‘Fed pivot’ to tighter policy faster is a one-way pivot and that the Fed will not back-track.

The Fed gets scarred if stocks fall another 10%, if so it will not tighten policy as quickly as the markets currently expect.

Remember all that government debt still exists; that the interest payment must be paid on that debt, and higher interest rates mean higher payments.

There is also the housing market to consider, yes it might be bloated but a housing crash is not something the US administration would be pleased about heading into mid-term elections.

So, in our view, the ‘Fed put’ is not over forever because we expect central banks will flinch!

The Bitcoin Collapse

Now let’s talk about the decline in Bitcoin.

Yes, equity markets are down, with the S&P 500 close to 10% of its highs, and the NASDAQ down 15%. However, Bitcoin is down almost 50% off its highs as of the time of writing.

The significance of this is that this is the sixth time since the end of 2017 that Bitcoin has declined more than 40%.

Yes, that’s right, six times in just over four years. And remember a 50% decline takes a 100% gain to put it back at the same place it started.

Over this same period, the largest decline in the S&P 500 was 34% at the start of the Covid crisis. The second largest decline was 20% at the end of 2018.

And gold’s largest decline over this time period was 19% after reaching its all-time high in August 2020.

Bitcoin has been touted as a gold alternative in a portfolio.

However, two reasons this does not hold are that Bitcoin does not act as a portfolio diversifier the same way that gold does.

Meaning that Bitcoin and equity markets have both moved significantly down. Also, Bitcoin has magnified the decline of the equity markets.

Gold on the other hand has had a small increase since the beginning of the year.

The second issue is the sheer volatility of Bitcoin. Six declines of more than 40% in four years is quite a speculation!

Yes, the gold price has had the peak to trough declines over bear cycle periods. However, over 40% declines have occurred four times in the last 50 years. This is quite the difference in frequency to be sure!

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