The ‘Fed Put’ Is Back, and That’s Great News for the Stock Market

Markets had thought the Fed “put” was dead. But the possibility of its return is growing stronger.

What’s the Fed Put? It’s when the Federal Reserve signals that it will reduce rates if the economy or financial markets fall apart. The concept originated in the 1980s and 1990s, when markets became conditioned to expect the Fed to step in during times of financial market stress—causing the stock market to rally.

The phrase is derived from the options market, where investors can hedge their bets on stocks and bonds by buying insurance against them. Investors don’t need to buy the “Fed put,” though. It existed implicitly, offering comfort whenever markets would slump too much.

The put works well when inflation is benign and growth is the focus, as was the case for much of the four decades leading up to the end of the pandemic. It works less well when inflation is an issue and the Fed is formed to balance sustaining the economy with tamping down inflation. It was one reason the Fed put was nowhere in sight during the bear market of 2022. Fighting inflation, rather than boosting growth, was the Fed’s goal.

Comments made last week, however, suggest that the put may be making a comeback. Yes, the central bank kept the federal-funds rate unchanged between 5.25% and 5.5%, but Fed Chairman Jerome Powell said during his press conference that all options for monetary policy are on the table going forward. The Fed’s official statement on rates read:

“In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook,” meaning that it’s open to cutting rates if inflation is low enough. “The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge.”

It’s a balanced statement, and deservedly so. The rate of inflation has fallen from its postpandemic peak, yet remains stubbornly above the Fed’s 2% goal, while growth is strong, but decelerating. The result is that the Fed must leave rates where they are for now. But it also suggests that Powell is ready to cut if economic conditions make it necessary.

Yes, the current put is much different than the one used during the disinflationary 1990s, 2000s, and 2010s. Then, it seemed nothing could push inflation and economic growth above the low single digits, and the Fed was much more willing to send strong signals to markets that it was ready to lower rates. Now, inflation has become a more pervasive part of the economy, so Powell’s put may come across as less overt. Nonetheless, a mild form of a Fed put is better than no put at all.

“That’s one reason I’m pretty constructive on markets for the second half of the year,” says Rhys Williams, chief investment officer at Wayve Capital Management. “Any weakness in inflation, you do have that potential Fed put.”

The stock market might not even need the Fed put, though. This earnings season has been strong, and the Atlanta Fed’s GDPNow tool puts the economy on pace to grow by 4.2% during the second quarter. Together, they make a powerful mixture, according to Chris Senyek, chief investment strategist at Wolfe Research.

“The combination of Powell reviving belief in the ‘Fed Put’ last week and very solid earnings trends coming out of first-quarter earnings season leave us constructive on the [market] outlook,” he writes.

That smacks of the market environment in 2019. The S&P 500 headed into that year having dropped in 2018 on the back of a late-year selloff, as the Fed was lifting rates. Then, the Fed held rates steady in January 2019 and said it would carefully consider inflation and other economic data in making its rate decision. Markets took that as a signal that the Fed would eventually cut rates, and the S&P 500 gained 29%.

This year probably won’t turn out exactly like 2019, but with the Fed put back, it should still be a pretty good year.

Write to Jacob Sonenshine at [email protected]