A stronger market might be all the Federal Reserve needs to get back to raising rates
Before investors get too comfortable with the rebound in share prices, they should beware the “Yellen call.”
That is the opposite of the so-called Greenspan put that investors once thought underpinned share prices. And while that was supportive, the Yellen call is likely to keep stocks in check for some time.
For some investors, the Fed’s caution might bring to mind the late 1990s. Back then, traders became convinced that if stocks fell too hard, the Fed under then-Chairman Alan Greenspan would cut rates and stem losses. This earned the moniker the “Greenspan put.” It was as if the Fed had provided investors with a put option, which insures against losses
Consider what happened last summer. The Fed was intent on raising rates in September. Then worries about China torpedoed stocks, and the Fed signaled a delay—which some investors took as a sign it wouldn’t raise rates at all in 2015.
The Fed no longer looks likely to raise rates four times this year, as it had once hoped. But it is still intent on raising them.
The main sticking point is markets: As soon as the Fed feels like they are reasonably well behaved, it will be a lot more comfortable with tightening again. Indeed, rather than thinking the Fed has provided them with a put, investors might be better off thinking they have provided the Fed with a call option.
As with the writers of a call, investors will end up paying if stocks rise above the strike price. In other words, the stronger the stock market becomes, the more emboldened the Fed could feel about its ability to raise rates.
If it does so, that could put a lid on rising share prices and valuations. This doesn’t mean that stocks will necessarily slump due to the Fed’s actions. But it will result in a sort of push-and-pull between investors and the Fed. That could mean share prices may be in for a prolonged period of subdued gains.
And with the S&P 500 now about 6% away from its highs of the fall, the strike price for the Yellen call might not be too far away.