Investing.com -- Recent actions by the Federal Open Market Committee (FOMC), particularly the decision to cut interest rates by 50 basis points, have triggered debate about their broader economic implications.
Yardeni Research offers a pointed observation: the current environment resembles the conditions that led to a stock market "meltup" in the 1990s.
A meltup refers to a sharp and unsustainable rise in asset prices driven more by a surge in investor sentiment than by improving fundamentals.
Yardeni’s comparison to the 1990s is significant. During that period, the U.S. economy experienced low inflation and robust economic growth, creating an environment in which asset prices, particularly stocks, soared.
A combination of factors, including aggressive monetary easing, low interest rates, and technological advancements, resulted in a prolonged bull market.
However, this surge in stock prices, particularly in the tech sector, led to a bubble, which burst in the early 2000s.
Yardeni suggests that the recent rate cuts, despite an already strong economy, set the stage for a similar trajectory.
The stock market has already demonstrated signs of frothy valuations, and further easing could accelerate those trends.
By removing recessionary risks, the Fed's policy encourages more liquidity in the market, fueling a potential stock market rally driven by investor exuberance rather than solid economic fundamentals.
The decision to cut rates when unemployment is low and growth is solid carries inherent risks. According to Yardeni, the FOMC’s move could stimulate an economy that does not need further boosting. This policy could push asset prices into overvaluation territory, stretching valuations and increasing macroeconomic volatility.
“Hence, we raised our subjective probability for a 1990s-style stock market meltup from 20% to 30% last week,” the analysts said.
In the 1990s, the market's meltup culminated in the dot-com bubble. Yardeni implies that a similar pattern could emerge if investors' risk-taking is emboldened by low rates.
The surge in liquidity could lead to excessive speculation, particularly in technology and growth stocks, where valuations are already stretched.
FOMC Chair Jerome Powell’s decision to lower rates, Yardeni suggests, is likely motivated by a desire to prevent unemployment from rising significantly, especially after a period of high inflation.
However, this choice to prioritize avoiding recession risks may increase the chances of overheating.
Yardeni points out that Powell’s decision seems to avoid short-term economic pain at the cost of long-term stability, which could mirror the Fed’s approach in the 1990s.
While Powell and other Fed officials argue that the current inflation outlook is benign and that further rate cuts will help steer inflation toward their 2% target, Yardeni expresses caution.
Analysts flag the potential for higher long-term inflation and volatility as the market digests the consequences of easier monetary policy.
Yardeni remains optimistic about the long-term prospects for productivity growth, which could allow the economy to grow without igniting runaway inflation. The analysts describes a “Roaring 2020s” scenario where technological advancements drive productivity and support sustained economic growth.
Nevertheless, Yardeni warns that even if this optimistic scenario unfolds, a stock market meltup could lead to a subsequent correction or even a crash.