Has Fed chairman Jerome Powell quietly ended the “Fed put” at a time when soaring bond yields and stretched asset valuations have increased the chances of a market meltdown?
It all feels so 20th century. Soaring bond yields, growing union activism, rising oil prices and unsympathetic central banks who see their main job as curbing overly strong demand, rather than soothing market jitters.
Since March 2022, the Fed has hiked interest rates at the fastest pace since the 1980s, lifting its benchmark rate from near zero to a target range of between 5.25 per cent and 5.5 per cent – the highest level since early 2001.And the Fed is also shrinking its bloated $US8 trillion balance sheet at a clip of $US95 billion a month, even though this is exacerbating the indigestion in the US bond market.
“We may be living in a world where the interest rate is less of a tool for guiding the economy than it used to be”, he said. “That means when things need to be cooled off, interest rates are going to have to be more volatile than they have been in the past.” The idea that the Fed would do what was necessary to calm turbulent markets emerged just over 25 years ago, following the collapse of US hedge fund Long-Term Capital Management.The hedge fund, which boasted Nobel Prize winners Robert Merton and Myron Scholes among its top ranks, claimed to have discovered a way to generate huge returns with minimum risk by taking massive, highly leveraged bets on assets it believed were mispriced by markets.
The Fed’s actions encouraged investors to expect the US central bank would ride to the sharemarket’s rescue whenever it suffered steep losses.
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