Fed Rate Cuts Raise Chances of 90s-Style Stock Market Meltdown, According to Yardeni

Investing.com — Recent moves by the Federal Open Market Committee (FOMC), notably the decision to reduce interest rates by 50 basis points, have sparked discussions regarding their broader economic impact.

Yardeni Research notes that the current situation is reminiscent of the conditions that led to a stock market “meltup” in the 1990s. A meltup is characterized by a rapid and unsustainable increase in asset prices, driven more by heightened investor sentiment than by improving economic fundamentals.

The comparison to the 1990s is particularly noteworthy. During that time, the U.S. economy enjoyed low inflation coupled with strong economic growth, fostering an environment where asset prices—especially stocks—rose sharply. Factors such as aggressive monetary easing, low interest rates, and technological innovations contributed to an extended bull market. However, this surge, especially within the tech sector, culminated in a bubble that burst in the early 2000s.

Yardeni suggests that the recent interest rate cuts, even in the context of a solid economy, may be setting the stage for a similar outcome. The stock market has already shown signs of inflated valuations, and further easing could exacerbate these trends. By diminishing recessionary risks, the Fed’s approach encourages more liquidity in the market, potentially igniting a rally driven by investor enthusiasm rather than solid economic indicators.

There are inherent risks associated with cutting rates while unemployment is low and growth is steady. According to Yardeni, FOMC’s strategy could support an economy that requires no additional stimulus, potentially pushing asset prices into overvalued territory and heightening macroeconomic volatility. The analysts increased their estimate for the likelihood of a 1990s-style stock market meltup from 20% to 30%.

In the 1990s, the market’s meltup eventually led to the dot-com bubble, and Yardeni warns that a similar scenario may arise if low rates embolden investors to take on more risk. The influx of liquidity might foster excessive speculation, particularly in technology and growth stocks, where valuations are already high.

Yardeni believes FOMC Chair Jerome Powell’s decision to lower rates is primarily aimed at preventing significant unemployment, especially following a phase of elevated inflation. However, prioritizing the avoidance of recession risks may increase the potential for overheating in the economy.

The analysis indicates that Powell’s approach could be attempting to sidestep short-term economic discomfort at the expense of long-term stability, paralleling the Fed’s strategies in the 1990s. While Powell and other Fed officials maintain that the inflation outlook is favorable and that further rate cuts can help regulate inflation toward a 2% target, Yardeni advises caution. Analysts indicate the possibility of heightened long-term inflation and volatility as the market adjusts to more lenient monetary policy.

Yardeni remains hopeful regarding the long-term potential for productivity growth, which could enable the economy to expand without triggering rampant inflation. He envisions a “Roaring 2020s” scenario, where technological advancements spur productivity and facilitate sustained economic growth. Nonetheless, he cautions that even in this optimistic scenario, a stock market meltup could lead to an eventual correction or crash.