The first day of the Federal Reserve’s Humphrey-Hawkins testimony appears to have been well-received, at least by equity markets. During yesterday’s testimony, Chair Yellen reiterated that the bank is continuing to look to tighten policy while also preparing to start reducing the balance sheet by the end of this year.

What might not have been expected, and what may have driven bulls across the equity space was the last paragraph contained in the Monetary Policy Report to the Congress. After much of the report offered an upbeat tone towards forward-looking economic conditions, the last paragraph echoed what has become known as the ‘Fed Put’. The Fed Put is the idea that the Federal Reserve can re-ignite stimulus in the event that equity market declines became too worrisome. This is like a sense of support for equity market participants, as this seemingly attempts to rule out the possibility of another financial collapse.

The exact line in the Fed’s Monetary Policy Report to the Congress is as follows:

“However, the Committee would be prepared to resume reinvestments if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal funds rate. More generally, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.’

So, Chair Yellen basically said ‘we’re going to continue to tighten policy, but if things break, we’ll jump back in with more QE, using as much size and force as necessary to quell the issue.’ This basically functions like a put option for the Federal Reserve, and this isn’t the first time that this has happened. Alan Greenspan used similar policy maneuvering as he would normally reduce interest rates in response to equity market declines of 20% or more. This became known as the ‘Greenspan put’, and he used it after the 1987 S&L crash. Many point fingers at the ‘Greenspan put’ being at least partially responsible for the dot-com crash in the year 2000.

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