MOST believe that US President Trump’s attacks on the US Federal Reserve over the past few months represent a serious threat to the central bank’s independence, and that this is objectionable because an independent Fed is essential to instil confidence whenever the Fed adjusts its policies.
That’s the theory – the real-world reality, however, is that the Fed is actually far from truly independent, often basing its actions on the health of the stock market.
At the heart of the myth of Fed independence lies its interventions in times of market turmoil which have given rise to the “Fed put’’ in the market’s collective consciousness.
The Corporate Finance Institute defines it as “a commonly used term in financial markets to describe the belief many market practitioners hold that the US Federal Reserve will step in with accommodative monetary policy to buoy markets, specifically the US equity market, if prices fall too fast too quickly”.
“Put’’ is used because put options gain value in a falling market and are often bought as protection from large market plunges.
It is quite ironical and perhaps even funny when you think about it: In response to the crash of October 1987, then-Fed chair Alan Greenspan slashed rates to zero to bail out Wall Street. Unbridled deregulation followed in the 1990s and early 2000s, spawning a massive property bubble in the US real estate whose crash later triggered the sub-prime crisis in 2008.
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This in turn prompted the Fed under Ben Bernanke to employ even more lax policies to prop up a cratering and crooked US financial system that had sold worthless “minibonds’’ and “high-yield notes” to unsuspecting investors around the world (Singapore included).
At its most extreme, the “Fed put” involved growing its balance sheet from US$2.2 trillion in 2008 to an astonishing US$9 trillion by current Fed chair Jerome Powell in response to Covid-19, an expansion dubbed “quantitative easing” (QE), which was at the time described as the “Fed going nuclear” because Powell promised QE would be infinite if necessary.
The repeated deployment of the “Fed put” undermines the narrative of independence in a few ways.
First, it links monetary policy with financial markets, leading traders and investors to rely on the guarantee of emergency rescues. This leads to ever-higher prices and stretched valuations as is the case now, which forces the Fed to keep an even closer eye on the market in case it needs to intervene.
Second, bailouts blur the line between fiscal and monetary policy. By absorbing government debt or stabilising credit markets, the Fed enables expansive fiscal policy. Far from being independent, it actually becomes a partner in deficit finance.
It is ironic that these efforts, combined with Covid-related supply chain disruptions and the Russia-Ukraine conflict, have led to the spike in inflation that pushed the Fed to raise interest rates eleven times from near 0 per cent in March 2022 to 5.25-5.5 per cent in July 2023.
Despite these hikes, Wall Street continues to scale new heights because of the entrenched position the “Fed put” occupies.
Fed independence is therefore actually merely a useful myth, one that serves to reassure the public that technocrats set monetary policy, and not politicians or the financial markets.
The reality, however, is different. The Fed’s role as both crisis manager and market backstop through its provision of the “Fed put” means that its independence really only exists more in theory than it does in practice.
