Don't Count on the Fed If the Market Tumbles -- Heard on the Street
After months of placid markets, many investors have probably forgotten how much they have relied in recent years on the Federal Reserve to halt any meltdown. Now that volatility has returned, the Fed may not be there anymore.
This was a nerve-racking week in financial markets. At best, it now seems like the White House and congressional Republicans will have a harder time pushing through tax cuts. And at worst? This week Wall Street analysts began passing around stock-market charts from the Watergate era.
The so-called Fed put, where the central bank steps in to help stop a selloff, has been part of the market's dynamics for years. Starting with the financial crises of the 1990s, the central bank has regularly put planned rate increases on hold, or rushed in with rate cuts and other easing actions, during stock-market routs. That history seemed on investors' minds during Wednesday's stock-market selloff, with futures showing them dialing back their rate-increase expectations for this year.
But now there are compelling reasons to believe that the Fed won't come to the market's rescue.
First, a big reason the Fed has been so quick to act was that the economic environment seemed so fragile that not acting might put the economy at risk. That was true as recently as early last year, when it dialed back its plans to raise rates in response to a tangle of emerging-market, debt and currency woes that threatened to sap the global economy.
Now, with the global economy healthy and growing, falling stock prices don't seem nearly as dangerous.
Second, the stock market's influence on consumer spending seems less certain than the Fed once believed. This is partly because not as many Americans are invested in the stock market anymore, and those that do are mostly better off. It is also because after years of rising stocks and so-so consumer spending, economists have begun to think that a rising stock market doesn't have much of an impact on consumption. Rather, it was the economy's influence on both stocks and spending that was at work.
Third, the Fed thinks the stock market is expensive. The minutes from its March rate-setting meeting pointed out that price-earnings ratios had become even more stretched, and that some Fed officials "viewed equity prices as quite high relative to standard valuation measures." A Fed that has grown concerned about valuation, especially because it has been criticized in the past for fueling market excess, likely wouldn't be all that interested in propping up a market it already sees as pricey.
Of course, even with these considerations, a big enough fall would likely get the Fed to act. The problem for investors is that it is probably very far below where the stock market is now.
Write to Justin Lahart at firstname.lastname@example.org
(END) Dow Jones Newswires
May 19, 2017 12:16 ET (16:16 GMT)