Is This The End of the Central Bank Put?

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The idea of a Central Bank Put originated as the ‘Greenspan Put’ – and came into being after the Fed (under Greenspan) typically reacted to crises by lowering the Fed Funds rate and/or providing liquidity to markets. This in turn would calm markets hence participants came to the conclusion that whenever markets are in trouble the Fed (or other Central banks) would come to the rescue.

The Central Bank Put has been an integral part of our markets for around twenty years as a result of the many crises we have faced in that time.

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It can actually be argued that at least some of the crises have in fact been caused by risk taking that in turn may be due to the Central Bank Put. While that would certainly be an irony it is not necessarily an invalid suggestion.

But what if the Central Bank Put is losing its power? What if, after 20 years (more in the case of the bank of Japan), Central Banks have either run out of ammunition or their traditional tools are no longer seen as having a calming effect by markets?

I view this possibility as one of the biggest risks to markets in the coming months.

Over the past few weeks we have seen action by the PBoC in China and the BoJ in Japan as well as rhetoric from the ECB in Europe. All were met by only limited enthusiasm by markets and volatility continued within a day or so from each announcement.

The US Federal Reserve is now in a delicate position. If they slow down their interest rate hikes or indeed resort to easing due to the market turmoil, this may well be taken as a sign of panic by markets; so it may actually have the opposite effect to what they desire. Yet continuing to hike during market volatility and while risk assets are dumped is unhelpful too. Being a Presidential election year further complicates matters (I understand the Fed are supposed to be politically impartial but at the end of the day the Governor is a political appointee).

If more QE is required in the US would it not be a sign that previous QE has failed to provide lasting help? Therefore, even further QE may be taken negatively by the markets (perhaps after a day or two of relief rally by risk assets).

So I believe we face a huge test of Central Banks this year. They are likely to need far stronger measures than before to calm the markets if market participants no longer react to or believe in, the Central Bank Put.

A world without a Central Bank Put could be a very volatile one but it is a world which I believe is an increasing possibility.

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Organic Financial Group Pty Ltd (ACN: 142 666 162) is a Corporate Authorised Representative (CAR No. 348956) of HLK Group Pty Ltd (ACN: 161 284 500) which holds an Australian Financial Services Licence (AFSL no. 435746). Any information or advice contained on this article is general in nature only and does not constitute personal or investment advice.

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