Economic outlook uncertain, "Federal Reserve bearish options" difficult to return in the short term?

Against the backdrop of an uncertain economic outlook, Powell hinted last Friday that it is not the right time to invoke the "Federal Reserve put option"—that is, to support a free-falling stock market through action.

Powell has repeatedly spoken decisively and taken action in response to economic challenges. For example, during the outbreak of the pandemic, he publicly committed to doing everything possible to support the economy; in 2022, he delivered stern remarks regarding inflation; and after the collapse of Silicon Valley Bank in 2023, he quickly acted to stabilize the financial markets.

However, this time, faced with new variables, the Federal Reserve's attitude appears particularly cautious. Powell stated that it is not appropriate to take the "Federal Reserve put option" at this time. He emphasized:

"We are also watching, which seems to be the right approach in a time of high uncertainty."

The Absence of the "Federal Reserve Put Option"

This "wait-and-see" attitude also means that the "put option" investors are hoping for may be absent in the short term. Although the March non-farm payroll data showed strong growth, Powell cautiously pointed out that this data was collected before the announcement of Trump's tariff policy. He stated:

"At present, the appropriate path for monetary policy is unclear, and we need to wait and observe how things develop."

Meanwhile, the feedback mechanism of the financial markets also complicates the Federal Reserve's decision-making. Stock price fluctuations can affect the economy by changing household wealth and expectations. However, during the early days of the Trump administration, various contradictory signals made it difficult for the Federal Reserve to make choices.

In a context where policies are still taking shape and markets have yet to stabilize, the Federal Reserve seems more willing to exercise restraint. This is because tariff increases may be accompanied by other fiscal and tax measures, which could again alter the outlook. Alan Blinder, a Princeton University economics professor and former vice chairman of the Federal Reserve, stated that Powell's "top priority is to eliminate the perception that the Federal Reserve will soon significantly cut interest rates."

Although Federal Reserve officials have never acknowledged that the "Federal Reserve put option" is one of their policy tools, Wall Street has firmly believed in its existence for nearly forty years. The term was originally referred to as the "Greenspan put option," created after former Federal Reserve Chairman Alan Greenspan cut interest rates and injected liquidity following the stock market crash on "Black Monday" in October 1987. However, currently, the Federal Reserve is caught between a potentially weak economy and inflation driven by tariffs, and thus may be set aside.

At present, based on the trends in the overnight interest rate swap market, market pricing indicates that the Federal Reserve will cut rates by 125 basis points by the end of the year, equivalent to five cuts of 25 basis points each. Just last week, the market was only certain of three rate cuts.

J.P. Morgan's Jay Barry strategist team expects that from now until January 2026, the Federal Reserve will decide to cut rates at every FOMC monetary policy meeting held, and they anticipate that by early next year, the upper end of the federal funds rate target range will decline to 3.0%

The Federal Reserve's Balancing Act Will Become More Difficult

Currently, the average tariff rate on approximately $3 trillion of annual U.S. imports is expected to rise nearly tenfold, from about 2.5% to 25% or higher. Reports indicate that the initial impact is expected to be reflected in prices, as producers and importers will pass at least part of the costs onto consumers.

Economists believe that these higher prices will translate into higher overall inflation within a year, potentially exceeding the Federal Reserve's 2% target by a percentage point or more. As households and businesses adjust to higher prices, demand is also expected to slow—this combination at least suggests stagflation.

In the face of stagflation risks, the Federal Reserve's balancing act will become more difficult. Powell and other Federal Reserve officials believe they have not yet reached a point where the goal of achieving inflation targets directly conflicts with maintaining low unemployment rates. Powell stated, "We are not in the 1970s," when double-digit inflation coexisted with relatively high unemployment rates.

Analysts also point out, "Don't expect the Federal Reserve to come to the rescue with emergency rate cuts," said Elias Haddad, senior market strategist at Brown Brothers Harriman:

"This is entirely a policy-driven market collapse, and the Federal Reserve has no reason to bail out the financial markets."