The Big Question for Markets: Is There a Kudlow or Powell ‘Put’?

These are unsettled times in financial markets.

Stock prices rose or fell by more than 1 percent in four of five days last week, and if anything those closing numbers masked even larger swings within each trading sessions. A common measure of expected stock market volatility is about to double its level from early January.

The proximate cause is pretty obvious: President Donald Trump is threatening a trade war with China and perhaps other trading partners. But beneath those daily headlines are two more fundamental questions: Is there a Kudlow Put? And is there a Powell Put?

More specifically, will the White House economic adviser Larry Kudlow (and his free-trader allies within the administration) be able to rein in the Trump administration’s trade stance if markets keep falling? And will the Federal Reserve’s chairman, Jerome Powell, be ready to take action, such as by delaying interest rate increases or even cutting rates, if markets tumble further?

If the answers are “yes,” there isn’t much to worry about and the stock market should be able to keep humming along at its current high levels. If it’s a “no,” well, in a word, uh-oh.

A “put” is an option contract that offers its buyer protection against losses. If you own a stock worth $100 and buy a put with a strike price of $80, you are ensuring the ability to sell for that price if you wish, so you can’t lose more than 20 percent of your money.

Back in the 1990s, traders started referring to the “Greenspan Put,” the notion that the stock market as a whole had the equivalent of a giant put option in the form of the Fed chairman Alan Greenspan. Amid an emerging markets debt crisis in 1998, the Fed cut interest rates to try to guard the United States against economic fallout, which helped the stock market gain a whopping 29 percent that year despite the global troubles. This notion that the Fed is always ready to act when the stock markets start to dip has almost become a piece of conventional wisdom in market circles over the years — often said with a bit of snark and implicit criticism of the Fed for supposedly bailing out investors whenever the going gets tough. Fed officials themselves hate the idea, and argue that they’re looking out for the economy, not markets.

Nonetheless, in the popular discourse the Greenspan Put gave way to the (Ben) Bernanke Put, and to the (Janet) Yellen Put, as Greenspan’s successors engaged in multiple rounds of “quantitative easing” in recent years.

Which brings us to the 2018 equivalents.

Early last week, the stock market was losing ground as the Trump administration rolled out plans for punitive tariffs on $50 billion in Chinese imports, and the Chinese government said it would retaliate with comparable tariffs on U.S. goods.

The market sell-off abruptly halted on Wednesday after Kudlow told reporters in the White House driveway, in effect, not to sweat the incipient trade war. He said it was possible the tariffs would never come to pass and that the president was “ultimately a free trader” who “wants to solve this with the least amount of pain.”

The Standard & Poor’s 500 index ended that day up 1.2 percent.

So the question is whether Kudlow — not so much the individual, but the trade war-averse faction within the administration of which he is perhaps the most visible member — and others are going to be in position to prevent the administration from doing anything economically destructive on trade. The pattern on trade policy through the first 14 months of the Trump administration has been to pair blustery talk — about pulling out of the North American Free Trade Agreement, for example — with more modest policy actions and negotiations that may avert real economic damage.

But the question is whether that dynamic is changing, with the departure of more internationalist voices within the administration like Kudlow’s predecessor, Gary Cohn, and the former secretary of state Rex Tillerson.

If Kudlow is able to offer only soothing words in the White House driveway — and those words aren’t matched by restraint in policymaking — the Kudlow Put will turn out to be fairly worthless. A warning sign about that possibility came Thursday night, when the administration threatened tariffs on an additional $100 billion in Chinese imports, in retaliation to China’s retaliation.

This is the kind of escalation that would, if it became policy rather than mere threat, be quite ominous for financial markets. Again on Friday, Kudlow offered calming messages, saying “there are all kinds of back-channel discussions going on.” But given the continued escalation after his earlier attempts at calm, the Kudlow Put didn’t quite work, and the market fell 2 percent that day.

Then there is Powell, who is in his second month as Federal Reserve chairman. He delivered a speech Friday that threw into doubt whether the Powell Put exists — at least with respect to potential economic disruption from a trade war.

He mentioned that business contacts had told Fed officials they were worried that trade tensions could spill into broader economic distress. But he did not go the next step of giving any hint that this might lead the Fed to reconsider its plans to raise interest rates gradually in the year ahead.

There’s good reason for that. If the trade skirmish escalates into a trade war, it will harm economic growth, but it will also be inflationary. Prices would rise for U.S. consumers in the near term because of the new tariffs, and would rise in the medium term as production of goods moved to less economically advantageous locations.

It is an economic problem that the Fed’s tools would be particularly ill suited to solve; the Fed can help address weak demand in the economy but can’t do much about a negative supply shock, which is what a trade war would be.

So it’s understandable that Powell would be quiet on the subject, and disinclined to float the possibility that Fed interest rate policy could or would prevent damage from a trade war. But if things continue to escalate, expect markets to hang on his every word even more in search of evidence that the Powell Put is real.

The way to think of fluctuations in the stock market, both last week and in the months ahead, is as a continuing effort to determine whether the Kudlow Put and the Powell Put exist, and if so, how powerful they may be.

But given Trump’s newfound willingness to chart his own aggressive path on trade policy, and the limits of the Fed’s tools in the event of a trade war, these may not be options contracts you want to rely on.