How Federal Reserve helped fuel the bull market in stocks

WASHINGTON — The decade-long bull market in stocks was fueled in no small part by the aggressive moves the Federal Reserve took after the 2008 financial crisis and the Great Recession to nurse the U.S. economy back to health.

The Fed took the extraordinary step of keeping its benchmark short-term rate at a record low near zero for seven full years. It also unleashed a series of unorthodox initiatives. They included a program in which for several years the Fed bought billions in Treasury and mortgage bonds as a way to force down long-term borrowing rates.

All that bond buying helped depress rates not only on loans but also on bonds and other fixed-income investments. A result was that demand for stocks rose as investors went seeking higher returns than they could get from low-yielding bonds. In that way, among others, the Fed's moves helped propel the bull market.

The Fed's role drew some criticism, mainly from conservative Republicans in Congress, who complained that the Fed's ultra-low rates risked creating dangerous bubbles in stocks or other assets that could burst with disastrous consequences for the economy. As a cautionary example, some pointed to the housing market bubble that had burst before the financial crisis and helped ignite it.

Here are the key policy steps the Fed deployed and their connection to the bull market:

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INTEREST RATES

In December 2008, at the height of the financial crisis, the Fed cut its benchmark rate, called the federal funds rate, to a record-low range between zero and 0.25 percent. The goal was to reduce loan rates for companies and individuals as much as possible to spur borrowing and spending and thereby help stimulate the economy. The economy, it was felt, needed an extraordinary level of support to recover from the worst financial crisis and the deepest economic downturn in seven decades. After leaving the funds rate near zero for seven years, the Fed began very gradually raising it.

Beginning in December 2015, the central bank has raised its key rate nine times, to a range of 2.25 percent to 2.5 percent, still low by historical standards. When it met in January, the Fed left rates alone and indicated that it wouldn't likely raise them again for at least several months. That expected pause has helped drive a rebound in stock prices.

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BALANCE SHEET

Among the steps the Fed took at the height of the 2008 crisis was to start an aggressive drive to buy long-term bonds to help drive down consumer and business loan rates. The program, called quantitative easing, or QE, involved three rounds of bond purchases. The Fed's vast increase in its bond portfolio ballooned its balance sheet more than four-fold — from under $1 trillion in 2008 before the crisis, to a peak of $4.5 trillion in 2017.

Like the ultra-low Fed funds rate, the torrent of bond purchases is thought to have led many investors to shift out of low-yielding bonds and into stocks, thereby boosting the stock market over time. Still, some critics argued that the Fed was distorting the bond market and would risk a dangerous disruption of the financial system once it began reducing those holdings. The Fed did begin that process in October 2017, allowing a portion of its bond holdings to run off its balance sheet as they matured. The Fed's balance sheet now stands at $4 trillion.

Some investors have fretted that the Fed might cut its bond holdings too much and end up slowing the economy by sending long-term rates up too high. But Chairman Jerome Powell told Congress last week that the Fed has been assessing the proper approach to its balance sheet and is close to announcing its final plans.

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FORWARD GUIDANCE

Besides keeping rates super-low and buying long-term bonds, the Fed over the past decade has leaned heavily on another tool: The use of its policy statements to provide "forward guidance" about the likely path of rates. After the financial crisis and recession, with its key rate already as low as it could go, the Fed used the wording of the statements it issued after its policy meetings to signal that it would keep rates ultra-low well into the future.

Over the seven years that the rate was left near zero, the Fed deployed a variety of such signals. It would signal that no rate hike was likely for a certain length of time, for example, or would peg any increase in rates to the unemployment rate falling below a specific level. It didn't work exactly as planned. Even after some such milestones had been reached, the Fed felt it had to keep rates frozen because the economic recovery was still lagging. And that caution helped support the bull market in stocks.

In January this year, the Fed said it would be "patient" about any future rate hikes. Investors interpreted that word as a signal that the Fed was putting rate increases on hold, and in response they sent stock prices surging.

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THE 'TAPER TANTRUM' AND OTHER MISCUES

The Fed's support for the nearly decade-long economic recovery — and, by extension, for the bull market — haven't been without missteps. Perhaps the biggest miscue followed one of the Fed's policy meetings in 2013, when Chairman Ben Bernanke suggested that if the economy continued to improve, the Fed would begin gradually reducing — or "tapering" — the bond purchases it was still making.

It might have seemed like a bland observation. But Bernanke's remark hit markets like a hammer blow, rattling investors and sending bond rates rising and stock prices sinking. It became known as the "taper tantrum," and it was hardly the reaction Bernanke had intended.

The chairman and other Fed officials spent the next few months providing assurances that the central bank wouldn't begin reducing its bond purchases until it was sure the economy could withstand even incremental reductions in those purchases.

In the end, the bond reductions were overseen not by Bernanke but by his successor, Janet Yellen. For three years, the Fed left the size of its balance sheet unchanged at $4.5 trillion. Finally, in October 2017, the Fed started gradually reducing its bond holdings by not reinvesting all the maturing bonds.

Powell told an audience in January that "the taper tantrum left scars on anybody who was working at the Fed at that time."

But Powell hasn't always avoided his own missteps. One occurred last fall at a time when investors were jittery about the steady increase in the Fed's benchmark rate. Answering a question during a moderated discussion in October, Powell said the Fed was a "long way" from neutral — the level at which its key rate is regarded as neither stimulating nor restraining the economy. That remark caused to investors to fear that the Fed might tighten credit more aggressively than markets were expecting. It was among the factors that sent stock prices plunging late last year.

Another contributing factor in that market dive was what Powell said at a news conference after the Fed had raised rates in December for a fourth time in 2018. Investors worried that Powell's responses didn't show sufficient concern about the risks facing the economy — from a global slowdown to President Donald Trump's trade conflicts.

Powell, however, addressed those worries in January, when the Fed left rates unchanged and reworked its policy statement to signal that it was aware of growing risks and would be "patient" in raising rates again.

Markets celebrated the about-face by sending stock prices surging.