The Greenspan Put
Alan Greenspan passed away this week at the age of 100. Greenspan was one of the most influential Federal Reserve Chairmen in recent history, serving as Fed chief for 19 years from 1987 to 2006. This was a period of record US economic expansion and a long, sustained period of low and stable inflation and unemployment. The S&P 500 Index quadrupled during his tenure, while the US economy grew at an average annual pace of 3.5%. The jobless rate averaged 5.5% and touched 3.8% in April 2000, which at the time was the lowest level since 1969. However, financial pressures were building in the final years of Greenspan’s term as mortgage-backed securities became more prevalent and riskier, leading to the Great Financial Crisis a couple of years later.
The Greenspan era saw incredible technological progress as the internet permeated ordinary life, much as artificial intelligence is doing now. Greenspan was also among the first to recognize the impact of technology on increasing productivity in the US, allowing the economy to grow faster than thought without inflation. This period also marked a debate over the Fed’s role in stabilizing financial markets and the belief that the Fed would ease conditions in response to a stock-market crash, or to prevent one. This belief was dubbed the “Greenspan Put.” Whenever markets cracked, the Fed cut rates and injected liquidity into the financial system. This included the 1987 crash just weeks into Greenspan’s tenure, the blowup of hedge-fund Long Term Capital Management in 1998, and the dot-com bubble bursting in 2000. The Greenspan Put may have been more of a myth, as later research showed, but was built into investor expectations for many years.
The “briefcase indicator” was a popular forecasting theory (though flimsy) used by Fed watchers in the 1990s and early 2000s to predict whether Fed Chair Greenspan would raise or lower interest rates. A bulging briefcase implied a potential shift in monetary policy, with possibly extra research, charts, and data stuffed in to persuade the FOMC to support a rate hike. A thin briefcase signaled that the status quo would remain with no major rate changes likely. Greenspan debunked the theory, jokingly stating that whether his briefcase was fat or thin simply “depended on whether or not my wife made me lunch that day”.
A New Era for the Fed
Economists still monitor the Fed’s statement on monetary policy closely after each of the Fed’s eight FOMC meetings during the year. Greenspan was famous for using confusing language to maintain flexibility in monetary policy, summarized by his well-known quote: “If I’ve made myself clear, I’ve misspoken”. The new Fed Chair, Kevin Warsh, is promising a new era for the Fed, with less posturing and more data-driven action. For one, specific forward guidance regarding future interest rate paths has been removed. Kevin Warsh’s first FOMC statement was just 162 words, the shortest for a regular meeting since 2007 and less than half the length of previous Chair Powell’s average statement of 397 words. Last Wednesday, the S&P 500 fell 1.2% on the day of Kevin Warsh’s first FOMC meeting as Fed Chair. The S&P has now fallen on all four “first Fed days” for new Fed Chairs since 1994. The Fed model of interest rate policy that Greenspan may have referenced suggests higher interest rates will be needed based on current inflation expectations. Projections show nearly half of Fed officials anticipate at least one or two rate increases before the end of the year to combat rising inflation, reversing earlier expectations for continued rate cuts.
Excessive Optimism
In a 1996 speech, Greenspan posed a rhetorical concern: “How do we know when irrational exuberance has unduly escalated asset values?” Greenspan was a bit early in raising this red flag. Equity markets surged for another three years after that, confirming that valuations can move well past rational levels and persist for quite a while. As Alan Greenspan also once remarked, “Excessive optimism sows the seeds of its own reversal.” While warnings about technology sector euphoria are not new, selling yesterday was triggered by a rout in South Korea related to major memory semiconductor chip stocks. The tech rout engulfed global stocks as worries about frothy valuations ignited a fresh round of volatility, coming after a nearly three-month surge in riskier assets. The pullback comes as equity markets close out the first half of the year with gains driven by easing geopolitical tensions, declining crude oil prices, solid corporate earnings and a revival of the AI trade. The economic signposts seem encouraging so far this year, and the 10-year Treasury hovers below 4.5%. But with less Fed guidance ahead, maybe the briefcase indicator will need to make a comeback. Stock market futures are indicated slightly higher this morning.
Soccer phenom Lionel Messi turns 39 today, and actress Mindy Kaling turns 47.
Christopher Crooks, CFA®, CFP® 610-260-2219