A dovish-hawkish game between the Fed and national monetary policy could lead to another market crash. It happened during Alan Greenspan’s tenure at the Fed, and it could happen again during Jerome Powell’s tenure, as the game left too many traders in the wrong market side and force them to liquidate their positions.
Anyone who has followed the FOMC meetings that set the nation’s monetary policy over the past few years should note that the Fed has been inconsistent in its handling of soaring inflation, oscillating back and forth between dovish and hawkish stances. For example, a few years ago, the Fed talked about inflation as a “transient” problem caused by temporary supply chain bottlenecks.
As such, it sees no need to change the ultra-easy monetary policy introduced during the pandemic recession.
The Fed’s dovish stance on inflation has led to a major rally on Wall Street, across all asset classes, with Bitcoin near $70,000. The rally included meme stocks with high valuations because they were enough speculators with enough cash to chase their stocks.
At the same time, low interest rates have fueled a red-hot housing market, with home prices hitting new highs and driving low-income Americans out of the market.
Unfortunately, this is not the case with the country’s central bank. Inflation isn’t going away anytime soon. Instead, it continues to this day, gaining momentum month after month. Prices at local supermarkets and nearby gas stations have risen, climbing to levels Americans haven’t seen since the late 1970s and early 1980s. Then the Fed decided to abandon its ultra-easy policy, first scaling back its bond-buying program and then raising short-term interest rates, putting some traders and speculators on the wrong side of the market. As a result, speculative assets on Wall Street such as small tech stocks, bitcoin and meme stocks collapsed.
In addition, markets were disappointed again last April when the Fed downplayed interest rate hikes with dovish rhetoric. For example, in a statement issued after raising rates by 75 basis points, the Fed communicated to Wall Street that “current rates are near neutral.” As a result, a rally in speculative assets helped Wall Street post its best performance since July 2020.
But that all changed last Friday when the Fed sent another hawkish message at the Jackson Hole Bankers’ Symposium. Once again, many traders were caught on the wrong side of the market, forcing them to liquidate their positions and sending all of Wall Street’s major stock averages sharply lower.
“As the saying goes, ‘Don’t fight the Fed.’ But investors have been doing it since shortly after the June FOMC meeting — fighting the Fed,” Greg McBride, chief financial analyst at Bankrate.com, said in a note. told the International Business Times in an email. “Powell hit back, making it clear that the Fed will continue to raise rates and keep them at restrictive levels until they are confident that inflation is heading towards its 2 percent target.”
That’s the hawkish statement, ending a rally the Fed helped create over the past four months with a dovish April statement.
“The rally in stock and bond markets this summer has eased financial conditions as the Fed tries to tighten policy,” McBride added. “However, the Fed has credibility issues with inflation and they won’t spare investors pain as they work to rebuild their anti-inflation credibility.”
But this has consequences.
“Powell’s speech on Friday underscored that the central bank’s determination to fight inflation includes sacrificing the economy to push it into recession,” Jan Szilagyi, CEO and founder of investment research firm Toggle AI, told IBT in an email.
But the market doesn’t seem ready for this scenario. So the Fed may be gearing up for another crash.
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