How long can the stimulatory magic of the central banks last?

Since late March we’ve witnessed the greatest short-duration surge of stock market prices in history.

Once investors saw that the Federal Reserve would pull out all the stops, they jumped back in . . . because, for the last near-40-years (1982 to 2020) “buy the dip” has always turned out well.

A pattern of forty years builds up a strong psychological affirmation and creates a lot of momentum. Two generations of Wall Street investors have been inured with “buy the dip” because Fed policy has accommodated such over that long span of time.

Both stock and bond prices reached insane levels of valuation before the current crisis. A reversal was inevitable, but, due to the “buy the dip” momentum, it figures to be a long and winding road down from the peak.

They talk about a “Fed put” (central bank intervention to buoy asset prices). It started after the 1987 crash. Since then it has never failed to lift the markets.

With that sense of power — and, so far, seemingly no downside — the central banks (not just the US Fed, but also the monetary authorities of all the key economies) have hit the stimulus button faster and harder over time. It had appeared that they went to an extreme after 2008. They had pushed interest rates to zero. To prop up asset prices they bought bonds like crazy. For example, the Fed balance sheet went from under $1 trillion in 2006 to over $4 trillion in 2016.

The central banks felt they had to do that because the global economy has been languishing. They swore they would “normalize” (let interest rates return to historical ranges and reduce their balance sheets) once strong growth resumed. But it never did.

And now a new crisis, a new economic downdraft. Facing underlying debt-bombs, verge-of-bankruptcies, and underfunded obligations, the Fed moved with breathtaking speed to go back into full-stimulation mode. Like a puppet, the stock market soared. Again, “buy the dip” (after the March declines) was rewarded.

But now . . . we’ll see . . .

The stimulus extremes in the wake of the last crisis (the Great Recession of 2007–2010) have now become ultra-extremes.

The financial world has been experiencing decades of an accelerating paradigm of deflationary tendencies offset by central bank stimulus. How long can the seeming magic of the latter last?