Written by: Simon Derrick | Chief Currency Strategist and Head of BNY Mellon Markets Strategy team, BNY Mellon
Last week marked the 30th anniversary of the 1987 stock market crash more commonly known as ‘Black Monday.’
As is always the case with milestone anniversaries of challenging periods in history, I think it is important to reflect on what happened and ensure we are still mindful of valuable learnings so we can either prevent a repeat of an incident, or at least be better prepared to tackle it head on.
When thinking about Black Monday, I think it’s worth highlighting one of the market forces that was arguably set in motion that day.
After the precipitous declines of Monday, October 19, 1987 – the Dow Jones Industrial Average had dropped 22.6% – and before the opening of financial markets the next day, the Federal Reserve issued a short statement.
It read: "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 bp 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.
Our own memory is that became common currency after Mr. Greenspan's "irrational exuberance" speech in 1996 while others argue it only emerged after the collapse of Long Term Capital Management in summer 1998 when the Fed once again stepped in to support markets.
What is clear is that by 2001 many believed the “put” existed. The dynamic is easy to see. Once investors became convinced there was a "Fed put" then the logical response was to take as much risk as reasonably possible, certain in the knowledge that central banks would be there in the bad times to minimize the losses with ever easier monetary policy settings.
The net result of this was that each bust (1998, 2000, 2008) was met by evermore extreme monetary policy responses that, in turn, provided even easier funding for those using leverage.
This matters right now because of the warnings that have emerged in recent weeks from a number of senior finance officials globally about market conditions.
The most forthright comments have come from Claudio Borio, Chief Economist at the Bank for International Settlements.
He warned that the present calm in bond markets belies economic conditions and can only be explained by the involvement of central banks. He also noted that "another factor could be market participants' belief that central banks will not remain on the side lines should unwarranted market tensions rise."
The attitude of the next chairman of the Federal Reserve towards this issue will be key.
Should they tackle the belief in the “put” before the bubble reaches its peak?
Should they wait for the next market downturn to emerge before disillusioning markets?
Should they tighten policy as much as possible now so that they have ammunition to deal with the next downturn?
Or should they just ignore the issue and effectively act as cheerleaders for ever higher asset markets?
This is why the current debate over the next chairman matters.
Chief Currency Strategist, Head of the BNY Mellon Markets Strategy Team
Simon Derrick is a managing director of BNY Mellon and is head of the BNY Mellon Markets Strategy team. Simon established the team more than 10 years ago, and has guided its development into a preeminent center of excellence within BNY Mellon. His insights and commentaries have made him an indispensable source for financial journalists around the world, and his frequent on-air appearances have made him a fixture on electronic news outlets.