Free markets to Fed markets: How modern monetary policy impacts equity markets, Putnins 2022

In what way did the stock market appear disconnected from the real economy during the early phase of COVID‐19?

While real‐economy indicators (GDP, employment) plunged, equities rebounded quickly—partly due to massive Federal Reserve interventions (e.g., bond purchases) that lowered discount rates and boosted market confidence, creating a seeming disconnect.

What key drivers caused the stock market to rally during the pandemic despite the deteriorating real economy?

• Central Bank Liquidity (expansive asset purchases, rate cuts),

• Lower Discount Rates (falling bond yields supported higher equity valuations),

• Investor Confidence in ongoing monetary support and eventual economic recovery.

How did the Fed respond to falling stock prices during COVID‐19?

The Fed expanded its balance sheet aggressively—buying Treasury bonds, mortgage‐backed securities, and even corporate bond ETFs. This injected liquidity, decreased yields, and raised investor confidence, thereby helping stabilize and lift stock prices.

What are the three main channels through which Fed actions affect equity markets, according to Putnins?

• Lower Discount Rates – Fed bond purchases drive yields down, lifting present values of future cash flows.

• Improved Macroeconomic Outlook – Stimulus signals support for growth and corporate earnings.

• Preferred Habitat/Spillover – Fed purchases reduce bond supply for investors, pushing them into equities, thus boosting stock demand and prices.

Why do Fed interventions create an asymmetric impact on stock markets?

The Fed responds rapidly to market downturns by expanding its balance sheet, which often triggers strong upward moves in equities. Conversely, balance‐sheet reductions or rate hikes happen more gradually, and markets can be more negatively sensitive when the Fed withdraws liquidity.

During the June 2022 market crash, what triggered the sharp decline in stock prices?

Investors expected a faster‐than‐anticipated Fed tightening (higher rates, balance‐sheet runoff) that would raise discount rates and reduce liquidity. This policy pivot from expansion to contraction rattled market confidence, causing a broad sell‐off in equities.

How does preferred habitat theory explain rising stock prices when the Fed buys bonds?

Large‐scale bond purchases reduce the availability (and increase the price) of safe bonds, causing investors with a “preferred habitat” for returns to shift into riskier assets like stocks, pushing those stock prices higher.

According to Putnins, how significant is the Fed’s balance‐sheet expansion in explaining the 2020 equity rebound?

Fed bond purchases accounted for around one‐third to one‐half of the post‐COVID crash rebound in stocks, with a 10% balance‐sheet shock driving an estimated 9% cumulative rise in equity prices over several weeks

How do timing lags between Fed actions and market reactions play out in practice?

The Fed often expands its balance sheet 2–5 weeks after detecting significant market stress. Equities then typically rally in the 1–4 weeks following the intervention, illustrating a delayed but potent impact on stock prices

Which sectors of the stock market are most sensitive to Fed balance‐sheet expansions?

Small‐cap and cyclical sectors (e.g., consumer durables, energy, technology) generally exhibit larger price moves in response to Fed interventions, while defensive industries (utilities, telecom) show smaller price swings.

Summarize the central lesson of “Free Markets to Fed Markets” in one sentence.

Modern monetary policy—particularly large‐scale asset purchases and aggressive rate changes—has materially altered equity market dynamics by decoupling valuations from near‐term economic fundamentals and shifting the markets toward “Fed-driven” rather than purely “free-market-driven.”