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‘Do They Have Enough Ammo?’: Markets Mull Potency of a Powell Put

‘Do They Have Enough Ammo?’: Markets Mull Potency of a Powell Put

(Bloomberg) -- As far as the risk-on crowd is concerned, Jerome Powell’s put is in play. The question in markets deluged by trade war tweets and economic gloom is how quickly it will be exhausted.

Stocks rallied the most since January on Tuesday in reaction to the Federal Reserve chairman’s three-sentence reference to monitoring risks and being prepared to act, and added to that on Wednesday. But long-term Treasury yields still reflect deep pessimism about growth, with 10-year yields at just 2.13% -- below the Fed’s policy rate.

In the best of circumstances, puts -- lingo for options used to protect against tumbling prices -- are an imperfect weapon for limiting losses. They can expire too soon, or cost too much. That Powell’s words calmed markets is good news for bulls today, but whether he timed them right and reckoned the expense correctly is about to become their next obsession.

“Do they have enough ammo, enough bullets?” said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments in Mountain View, California. If the Fed had a starting point of 4% -- rather than the 2.25% to 2.5% where its rates now sit -- “it’s very likely easier monetary policy would have a much bigger impact,” he said.

‘Do They Have Enough Ammo?’: Markets Mull Potency of a Powell Put

And with short-term rates pricing in more than half a point in easing by year-end, it’s not clear simply delivering on that will be sufficient to offset the impact of 25% tariffs being proposed for most goods from China and Mexico -- the top-two exporters to the U.S. -- by October.

With the upper bound of the policy rate at 2.50%, there’s substantially less conventional Fed firepower than in previous economic slowdowns. When the financial crisis hit, the rate was at 5.25% when the central bank began tightening.

How long the latest advance in the S&P 500 Index sticks will offer investors a gauge of just how big a factor the Fed might be. Recent dovish indications, such as Fed Vice Chair Richard Clarida’s opening the door to a cut in comments last Thursday -- gave equities only a fleeting boost.

While Clarida had said that downside risk could call for more accommodative policy, the S&P 500 by the end of the session closed off its highs as enthusiasm faded. Clarida didn’t comment on the outlook for Fed policy Wednesday, in speaking at the same event where Powell Tuesday said “we will act as appropriate to sustain the expansion.”

“Risk sentiment will continue to gyrate,” said Eleanor Creagh, a market strategist at Saxo Capital Markets in Sydney. “We could be in for a period of time toward the end of the year where, if we don’t see a resolution on trade, the equity markets will surrender to the bond market.”

‘Do They Have Enough Ammo?’: Markets Mull Potency of a Powell Put

Mike Wilson, chief U.S. equity strategist at Morgan Stanley, says the market is skeptical about the central bank’s ability to spur growth. “The Fed likely can’t fix what ails the economy at this point in the cycle,” Wilson wrote in a note Monday. He sees a slowdown thanks to an unwinding of the jump in investment from last year’s tax cuts.

The bull case is that a trade deal is coming nevertheless, giving a fresh wind to American stocks that haven’t known a bear market since the global financial crisis. Stocks advanced Wednesday after White House trade adviser Peter Navarro said tariffs on Mexico may not have to go into effect, though futures retreated Thursday in Asia after President Donald Trump said talks had made “not nearly enough” progress.

“It’s really just talk at this point, so a 25% tariff will not happen” with Mexico, said Hilary Kramer, chief investment officer at Kramer Capital Research. “It’s just games going on in Washington and that’s why this has become a buying opportunity.”

Yet if enough investors agree with Kramer to keep Tuesday’s rally going, some warn that could sow the seeds of its own destruction. For one thing, it would ease pressure on Trump -- who has repeatedly highlighted stocks as a gauge of his administration’s performance -- to abandon tariffs and accelerate trade deals.

And low yields alongside resilient stocks would leave U.S. financial conditions at levels that might not encourage the Fed to follow through on the market’s expectation of easing.

The pushback to that view is the Fed would be in danger of “causing a severe decline in risk assets when the sharp decline in inflation expectations are indicating monetary policy is too restrictive relative to the growth outlook,” Dennis DeBusschere, head of portfolio strategy at Evercore ISI, wrote in a note Tuesday.

For his part, Neil Dwane, a global strategist with Allianz Global Investors, told reporters in Hong Kong Wednesday that “I still think with only 2.25% interest rate in his policy toolkit, he will wait to see the recession and be reactive,” referring to Powell.

It’s worth keeping in mind that rate cuts at the onset of a recession historically haven’t been much help for stocks. That was the case in 2001 and 2007.

‘Do They Have Enough Ammo?’: Markets Mull Potency of a Powell Put

“The cut in U.S. interest rates would be expected to boost the stock market in the short term,” said Toby Wu, a senior analyst with trading platform eToro. But the impact “may not counteract the impact of the trade war,” he said.

On the trade front, the next pivotal date looms at the end of the month, when Presidents Trump and Xi Jinping have the opportunity of getting talks back on track when they attend the G-20 summit in Japan. In the meantime, the clock is ticking on Trump’s next round of tariff hikes, on about $300 billion of Chinese goods. And China’s preparing action against a list of “unreliable” companies. Ford Motor Co.’s China venture was already targeted with a fine Wednesday.

“If we look at political risk over history, markets have a hard time pricing it,” David Hunt, chief executive officer at PGIM, which manages more than $1 trillion. “Markets tend to underestimate it for a very long time and then all of a sudden there’s a significant event and we see a lot of volatility. What that says to most investors around the world is we will probably have a much more volatile summer than we’ve had over the last couple of months.”

--With assistance from Vonnie Quinn and Shery Ahn.

To contact the reporters on this story: Adam Haigh in Sydney at ahaigh1@bloomberg.net;Lu Wang in New York at lwang8@bloomberg.net;Eric Lam in Hong Kong at elam87@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Jeremy Herron

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