BNY Mellon: The Aerial View: The Fed Put & China

November 22, 2018

After the precipitous declines on Monday, October 19, 1987 - the DJIA had dropped 22.6% - and before the opening of financial markets the next day, the Federal Reserve issued a short statement that said: "The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system."

Whether or not this was the catalyst behind the market's subsequent recovery (alongside the Fed’s use of open market operations to drive interest rates down by more than 50 bps on the day to below 7%), this marked the start of an era during which investors came to believe in the power of central banks to manage severe market downturns.

Quite when the phrase "Greenspan put" first emerged remains open to question. However, what is clear is that by 2001 many believed the “put” existed. Subsequent events over the next 17 years have done little to counteract this idea.

It’s arguable that last week’s “conversation” between Fed chair Jerome Powell and Dallas Federal Reserve President Robert Kaplan provided the first tentative signal that the put remains in place.

When asked by Mr Kaplan to list the "headwinds" the economy may face in coming months, Mr Powell noted: “Slowing growth abroad. The tax cuts and spending increases that were enacted are providing some real boost right now, but that impetus is going to wear off over time.”

He also noted in the same session that recent weakness in housing was a concern and that corporate borrowing had caught the Fed's attention.

With Mr Kaplan himself flagging up slowing growth in Europe and China as a concern that could affect the US economy in an interview with Fox Business, and Richard Clarida noting there is “some evidence” of slowing global growth it did seem that Fed officials were sending a fairly consistent message.

Much as in January 2016, it is entirely possible that this change in tone from the Fed might be enough to relieve the pressure on the CNY.

Indeed, this may already be happening with USD/CNY NDF outrights through to one year making a series of lower highs since the start of the month.  It’s also noticeable that, in sharp contrast to US markets, Chinese equity indices have actually experienced relatively benign conditions over the past few weeks.

In line with this, those currencies that have demonstrated a high correlation with the performance of the CSI 300 since the summer have either stabilized against the USD (the TWD and KRW) or begun to make healthy recoveries (the IDR, AUD and INR) from the lows hit in late October.

It’s also telling that the underlying local equity indices beneath each of these currencies bar the AUD have also either stabilized or staged reasonable recoveries in recent weeks.