Will The ‘Fed Put’ Work On The Next Go-Around?

The Federal Reserve’s “180-degree turn” has worked swimmingly for borrowers and risk-takers alike. The 10-year yield has dropped from 3.24% to 2.62%. That may encourage households and businesses to lever up with more debt. Meanwhile, stocks are surging upward, reaching for the record heights experienced during the September-October peak.

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The question investors need to ask themselves now is, “Will the ‘Fed Put’ work on the next go-around?

It depends. And it likely depends on whether or not the U.S. is facing recessionary pressures.

Historically speaking, the Federal Reserve has successfully bailed out financial markets in a number of crises. The Fed successfully bailed out the largest hedge fund in the world, Long Term Capital Management, during the Asian Currency Crisis in 1998. Similarly, the Federal Reserve and other central banks/financial authorities successfully bailed out major European countries (e.g., Portugal, Italy, Greece, Spain, etc.) in the sovereign debt crisis of 2011.

On the flip side, the Fed failed to arrest the development of two 50%-plus bear market disasters in the last two decades. In spite of all the interest rate manipulation, in spite of all the jawboning, stock prices were still cut in HALF.

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Simply stated, when markets fell in conjunction with recessionary pressures (e.g., 2000-2001, 2008-09), the Fed was unable to ward off monstrous price depreciation. This suggests that the Fed will throw spaghetti at the proverbial wall in the next downturn, but little will stick until the completion of an ugly stock mauling.

Equally concerning, the Fed has turned “neutral” with the overnight lending rate at an exceptionally modest 2.25%. In the last three recessions (i.e., 1990, 2001, 2008), the Fed had to lower the overnight lending rate five percentage points to stimulate the economy.

How can the Fed lower rates 5% from 2.25%? With negative interest rates? $10 Trillion in quantitative easing (QE)?

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ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser ...

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Gary Anderson 1 month ago Contributor's comment

Sobering, interesting article.