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Analysis | Heard of the ‘Fed Put’? Powell May Be Selling Calls

Analysis | Heard of the ‘Fed Put’? Powell May Be Selling Calls

None of that is happening now, of course, because stocks refuse to retreat, so the Federal Reserve might have to shock markets into submission.

Over the past seven days, the S&P 500 Index has climbed 6.8%, leaving it down just 6.5% on the year. Meanwhile, home values — which arguably have an even bigger wealth effect than stocks — have surged amid inventory shortages and persistent demand from the large millennial generation that have more than offset the uptick in mortgage rates. All told, most Americans feel richer than they did before the pandemic, and 2022 hasn’t really changed that.

All of this is a problem for Fed Chair Jerome Powell, who is trying to address the country’s 7.9% inflation rate without tipping the economy into a recession. For a while, Powell tried to manage inflation expectations, telling Americans that the spike was driven by “transitory” factors. That made some sense as a strategy (even if it was ultimately wrong) because runaway inflation expectations can become a self-fulfilling prophecy. But that ship has sailed, so policy makers are now starting to get more aggressive, delivering the first interest rate increase since 2018 and ending a pandemic-era stimulus program.

Still, rhetoric remains an important monetary policy tool, and Powell is starting to use it more. On Monday, just five days after the rate decision, Powell gave a speech reiterating his willingness to raise interest rates by half a percentage point at coming meetings if necessary. The message reached the bond market and Fed funds futures, which are now pricing in the possibility of such a move in May. But equity markets refuse to fall into line. “So far they’re not getting what they were hoping for in terms of asset prices,” Moody’s Analytics Chief Economist Mark Zandi told me by phone Tuesday, referring to central bankers. “They’re probably scratching their heads.”

The housing market might be even harder and more perilous to cool than the stock market. With inventory still near record lows, the typical home in the Zillow Home Value Index is up about 3% since the start of the year and 34% since December 2019. Consider a theoretical American adult who entered 2020 with a $100,000 investment portfolio and a $250,000 home that was purchased recently with a 20% down payment. That person’s wealth would have jumped about 79% since then, and though his or her stock and bond portfolio might be down around 6% this year, the home value is still rising, magnified by leverage. Overall, the minimal declines in stocks haven’t hurt that household’s net worth accumulated during the pandemic. Instead of helping the Fed, the wealth effect continues to work against it. 

There’s also the issue of employment. The proportion of Americans 16 and older in the workforce plummeted during the pandemic, and it still hasn’t come all the way back, leaving a worker scarcity that’s forcing employers to pay up. If that continues, the U.S. could enter the feared wage-price spiral, in which companies’ costs rise, so they keep raising prices and workers demand even more to keep, and this inflationary episode drags on. As Powell himself suggested in a Dec. 15 press conference, the run-up in stocks and housing could be part of the reason some workers have felt comfortable leaving their jobs. “It has been pointed out by many,” Powell said at the time, “that the stock market is high, people’s portfolios are stronger — they may go back to being a one-income rather than a two-income family.”

The wealth effect has been under consideration in mainstream economics for at least 65 years, since Milton Friedman discussed the impact of household “windfalls” on consumption in his permanent income hypothesis. A couple generations later, wealth effects were championed by former Fed Chair Alan Greenspan, who told Bloomberg News in 2009 that “all of the statistical evidence indicates that the level of household wealth is a major factor in consumer expenditures,” a belief that underpinned the market’s notion of the “Fed put,” when the central bank sweeps in to ease monetary conditions to cushion a stock market in freefall. In recent years, speculation mounted that the Fed could even go so far as to buy equities itself to push up prices and help make everyone richer, but that was before 1970s-style inflation appeared. Now the central bank is fighting an entirely different problem.

There are many theories about the origins of the current inflation, with many blaming snarled supply chains and others the extraordinary wave of stimulus pumped into the economy during the pandemic (it’s probably a mix). If the problem is primarily on the supply side, there’s little that central bankers can do about that; they can only use their tools to bring demand back into some sort of equilibrium with the available supply.

Wealth is a good thing, of course, and policy makers wouldn’t want to take it away permanently — just long enough to address this inflation fiasco. It’s not clear if doing so will ultimately mean higher interest rates or just another few doses of “hawkish rhetoric.” But if markets don’t behave, the Fed has ways of making them.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.

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