Stocks reversed multi-week losses and you can thank Federal Reserve Chairman Jerome Powell. The week began with hand wringing over the potential Mexican tariffs. On Tuesday, Powell announced that the central bank was keeping an eye on trade developments, their impact on the U.S. economy, and would “act as appropriate to sustain the expansion.” Here’s the translation of that Fed-speak: “Investors, we got your backs and will cut interest rates if the tariffs cause the economy to dip.” After Powell spoke, stocks soared, logging their largest one-day gains in five months.
That reversal of investor sentiment was a great example of “The Powell Put,” a term that refers to a type of option contract. Options are financial instruments that represent the right (but not he obligation) to buy or sell something and they come in two flavors: calls and puts. A call gives the buyer the right to buy something (known as the underlying instrument, like a stock or a bond) and a put gives someone the right to sell the underlying instrument.
Purchasing a put can offer investors downside protection, because they make money when the underlying drops. So in the example of the overall stock market, the idea that the Federal Reserve might step in and lower interest rates if the economy dips has become synonymous with “don’t worry about the market dropping, because we all own Powell Puts…he and the other fed officials will come to the rescue if things look bleak.”
Is there evidence of a slow down? Economists have been warning that the U.S. economy downshifted in the second quarter to an annual growth rate of 1.5 to 2 percent, from the 3.1 percent first quarter. But have conditions worsened enough to prompt Fed action? The meh May employment report may not help clarify the issue. The economy added 75,000 new jobs and the previous two months were revised down, bringing average monthly job creation to 164,000. That’s not too shabby considering that we are in the tenth year of expansion. It marked the 104th straight month of gains.
The unemployment rate remained at 3.6 percent, matching a 49-year low. The broader rate (U-6), which adds in those too discouraged to look for work, plus part-timers who would prefer full-time, fell to 7.1 percent, a post-recession low. The U-6 rate peaked in Dec 2009 at a staggering 17.1 percent and now stands at the same level as late 2000.
Adding it up, it’s hard to make the case that the Fed should do anything but wait and see. Don’t tell that to investors, who are clinging to that Powell Put. Right after the jobs report was released, the odds of a quarter point June rate cut jumped from 10 percent a month ago to 37.5 percent. And the July meeting seems positively in the bag, with a near 74 percent chance, up from 16 percent in early May. Economist Joel Naroff says that investors may be disappointed, because to the Fed, the jobs report was a good one: “The economy is not falling off a cliff: It is just easing back. Thus, there is no reason to cut rates.”