Pricing a ‘Powell Put’

Mark Heppenstall

By Mark Heppenstall | February 22, 2018

Financial markets have a history of testing the incoming Federal Reserve (Fed) Chairman shortly after taking office. There is no better example than October 19, 1987, the day infamously known as “Black Monday.” The Dow Jones Industrial Average (DJIA) dropped more than 22% – the largest drop in a single trading session – just two months after Alan Greenspan was sworn in as Fed Chairman. Greenspan’s statement the next day helped soothe investor fears and affirmed the Fed’s “readiness to serve as a source of liquidity to support the economic and financial system.” Stock markets recovered losses quickly following his response and went on to surpass their pre-crash highs within two years. Fed policies designed to set a floor on equity valuations came to be called the ‘Greenspan Put’ (followed eventually by the ‘Bernanke Put’ and ‘Yellen Put’).

In today’s rapid information flow, we should not be surprised markets wasted little time giving Fed Chairman Jerome Powell his first financial stress test. On his first day as Fed Chairman, and after record low volatility throughout essentially all of 2017, the DJIA dropped more than 1,500 points at one point during the trading day while the VIX spiked. An increasingly popular VIX-related fund was completely wiped out in the sell-off.

This week’s chart highlights how short-term interest rates reacted to the recent equity market volatility and assesses the potential for a ‘Powell Put.’ I tracked recent pricing of the VIX against implied market odds for one or fewer Fed hikes this year, as measured through pricing of December 2018 Fed Funds futures.

Key Takeaway

In his first statement as Fed Chairman, and at least partially in response to recent market turbulence, Powell promised to “remain alert to any developing risks to financial stability.” As this week’s chart suggests, markets expect Chairman Powell to follow the path of his predecessors and provide a safety net to investors during times of extreme stress.



Disclosure Statement

The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

Read More...

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice.  The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete.  Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements.  Actual results may differ significantly.  Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.

Investing involves risk, including possible loss of principal.  Past performance is no guarantee of future results.  All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.

High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.

Copyright © 2014 Penn Mutual. All Rights Reserved. All trademarks are the property of their respective owners.

Read Less...

Leave a Reply