Image Source: Pixabay

There’s a significant disparity between the thinking of the Federal Reserve and Wall Street. Beware: it could lead to lots of volatility in the financial markets. Don’t be surprised if there’s even a crash-like situation.

The Federal Reserve has two goals in mind: manage expectations and make sure there aren’t panics and wild crashes. The Fed essentially manages expectations by issuing statements about monetary policy, providing projections, presenting speeches by Federal Open Market Committee (FOMC) members, and so on and so forth. In the case of panics and crashes, the Fed jumps in and uses tools to bring calm: interest rates and open market operations.

Wall Street, however, is all about making money, with a keen eye on risk. It looks closely at the economic data and what the Fed is saying, and tries to be ahead of the curve.

Whenever there’s a disparity between what the Fed and Wall Street say, it leads to volatility in the financial markets.

A prime example of this was between early 2007 and mid-2008. Back then, Wall Street was ringing alarm bells about a possible economic slowdown and saying the future might not be as bright as previously expected. The economic data was turning, too. On the other hand, the Federal Reserve kept saying it was watching the situation, and it repeatedly said that things were under control.

The end result? A significant amount of volatility followed across the board.

For some perspective, look at the following chart. It plots the S&P 500 between early 2007 and mid-2008.

(Click on image to enlarge)

Chart courtesy of StockCharts.com

During that time, the S&P 500 had three rallies with gains of more than 13% and two rallies with gains of more than seven percent. There were also several sell-offs during that period, and those sell-offs wiped out the gains very quickly.
 

What the Fed & Wall Street Are Saying

Fast-forward to now: Wall Street and the Federal Reserve are completely opposite in their thinking.

In an interview with CNBC, the New York Federal Reserve’s president, John Williams, said, “A recession is not my base case right now.” He added, “I think the economy is strong. Clearly, financial conditions have tightened and I’m expecting growth to slow this year quite a bit relative to what we had last year.” (Source: “New York Fed President John Williams Says a U.S. Recession Is Not his Base Case” CNBC, June 28, 2022.)

The rhetoric from other key figures at the Federal Reserve has been similar. They’ve suggested that, even if there’s a recession, it will be mild, and that there aren’t many reasons to worry. Not too long ago, the Federal Reserve’s chair, Jerome Powell, said, “We hope that growth will remain positive…overall the US economy is well-positioned to withstand tighter monetary policy.” (Source: “Powell Says US Economy in Strong Shape, Fed Can Avert Recession,” BNN Bloomberg, June 29, 2022.)

Wall Street, however, has a gruesome view.

The CEO of JPMorgan Chase & Co (NYSE: JPM), Jamie Dimon, said, “You know, I said there are storm clouds but I’m going to change it… it’s a hurricane.” He also said, “JPMorgan is bracing ourselves and we’re going to be very conservative with our balance sheet.” (Source: “Jamie Dimon Says ‘Brace Yourself’ For an Economic Hurricane Caused by the Fed and Ukraine War,” CNBC, June 1, 2022.)

ARK Investment Management LLC‘s CEO, Cathie Wood, said, “We think we are in a recession.” (Source: “Cathie Wood Warns U.S. Is Already in a Recession,” MarketWatch, June 28, 2022.)

The list of people, banks, and funds on Wall Street saying a slowdown is approaching and that things don’t look bright keeps getting bigger.
 

What’s Next?

Don’t be complacent. We could be in for a roller coaster ride in the coming months. Historically speaking, when those with money don’t agree with what the Federal Reserve says, things get treacherous.

The first half of 2022 was one of the worst on record since the 1970s when it comes to stock market performance. Bonds have witnessed a severe sell-off. Other assets have also taken a huge tumble.

In times like this, the top priority for investors should be capital preservation. There will be wild rallies, but they might be followed by rigorous sell-offs. The wild swings could take a huge toll on investment portfolios. Sticking to quality investments might help.

The market will only settle down once the Federal Reserve and Wall Street are on the same page, and it could be some time until that happens.

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