The Fed put is back — and in a stronger, more flexible form

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is chief market strategist at Jefferies

There is plenty of healthy debate out there on the outlook for Federal Reserve rate cuts during 2024. And to be sure, you can find just about any forecast you like from the standard pool of professional pundits.

Typical examples run something like this: “They will cut rates every meeting starting in March”, or “they will cut every other meeting starting in May”, or “they will cut only twice, starting in September”, or “they will . . . blah blah blah.” But the differences in these rate forecasts do not translate into meaningful changes for the risk asset outlook. For me, the most important part of a Fed policy forecast in 2024 does not involve using the deceptively hubristic word will; rather, it focuses squarely on the far more humble can. 

Here is my version of the outlook for monetary policy in 2024: The Fed can cut quickly and the Fed can expand the balance sheet aggressively, if things get messy. That has huge ramifications for the performance of riskier assets such as equities. Specifically, it implies that the Fed put structure — the idea that the central bank will intervene to support markets and economies in times of turmoil — is back in place.

To be frank, a forecast of what they will do is only meaningful for a bunch of leveraged short-rate-focused hedge fund traders who play meeting-to-meeting odds. But a forecast of what they can do affects regular folks, those who are just looking at the medium- to long-run performance of credit and equity assets. The critical change for Fed policy in 2024 centres around the Fed’s renewed ability to be a backstop for market and economic stresses. Any finger-to-the wind prediction of what they ostensibly will do, given some dubious assessment of recession risks, has no value in my world. 

Now remember, for the past two years the Fed put has been largely unavailable to us investors in times of stress. It was only in late 2024, when Fed chair Jay Powell finally signalled that the employment side of the dual mandate was returning to an equal weighting relative to the inflation side, that we got our put back. And there is no doubt that risk assets have dearly missed this put. When the S&P 500 index dropped from 4,800 to 3,600 in 2022, did the put get exercised? No! Powell just kept telling us that we had to take the pain while he fought back the revival of those inflation demons from the 1970s. And even in 2023, when so many were calling for rate cuts because of some half-baked prediction of impending economic doom, Powell just kept increasing them.

The real story for 2024 is what the Fed can do. Powell can once again provide a market and economic backstop. I have no idea how many times the Fed will cut, when it will start or how far they go on its quantitative tightening programme to reduce its balance sheet. All I know is that Powell now has my back in times of stress, given his victory in the battle against the great supply-side inflation shock of 2021-22.

With that said, it is important to recognise that the put structure has evolved substantially. Under the past model, if things got messy, central banks cut. Then, if rates hit the effective lower bound, quantitative easing started. Further, if there were severe pockets of financial market stress, they introduced balance sheet funding facilities into the backstop, with inelegant acronyms such as the CPFF, AMLF, TAF, TALF, PDCF, and so on.

In our two past major rate-cutting cycles, during the financial crisis and the Covid-19 pandemic, both QE and funding facilities only came into play once rates hit zero. But over the past 18 months, we have seen funding facility put structures introduced when rates were not at zero.

The European Central Bank started this trend when it created the transmission protection instrument for bond buying; the Bank of England followed with its gilt purchase programme; and, finally, the Fed introduced the bank term funding programme after the collapse of Silicon Valley Bank. When it looked as if policy was beginning to bite too hard in certain sectors, funding facilities came into play. Adding liquidity in one sector while subtracting it in others has now become a critical feature of the central bank backstop. And it has created enormous flexibility.

In fact, one could argue that the overall power of this fully loaded global central bank put structure has never been greater. Policymakers can now provide targeted liquidity to weak links in the financial markets, even while sticking with a restrictive overall stance designed to anchor long-run inflation expectations. In sum, the put is not just back in 2024, it is stronger and more flexible than ever. Good luck trading.