Will the Fed pause its rate hikes as markets correct? That is the question that everyone is trying to answer. Of course, after more than a decade of monetary interventions, investors have developed a “Pavlovian” response to market declines and the “Fed Put.”
Classical conditioning (also known as Pavlovian or respondent conditioning) refers to a learning procedure in which a potent stimulus (e.g. food) is paired with a previously neutral stimulus (e.g. a bell). What Pavlov discovered is that when the neutral stimulus was introduced, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological “pairing” of the stimuli.
Importantly, for conditioning to work, the “neutral stimulus,” when introduced, must be followed by the “potent stimulus,” for the “pairing” to be completed. For investors, as each round of “Quantitative Easing” was introduced, the “neutral stimulus,” the stock market rose, the “potent stimulus.”
Each time a more substantial market correction occurred, Central Banks acted to provide the “neutral stimulus.”
So, with the market having one of the roughest starts ever to a new year, investors are asking the question:
“What does this mean for the economy and how bad does it need to be for the Fed to pause?”