<< Read Part 2: When The Fed’s Crystal Ball Fails, Part II  

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Today, I’d like to take you back two and a half decades ago… to the holiday season of 1997.

My career on Wall Street had brought me to London.

I started my own analytics group from scratch in 1993 and was promoted to Senior Managing Director at Bear Stearns. 

The city was beautifully decorated and as festive as ever. London does Christmas right!

However, as Christmas approached, my colleagues and I were struck by one thing…

The speed at which banking firms were canceling their once lavish holiday party plans. 

But more on that in just a moment…

The Fed Is This Year’s Christmas Grinch

As we close out the year, we find ourselves in a very different spot from where we opened it. 

High inflation, a slowing economy, and a stubborn Fed that’s been on a break-neck rate-hiking pace, yet will have no choice but to pivot.

When inflation began to creep upward in the early part of the year, Federal Reserve Chairman Jerome Powell declared an end to the use of the term “transitory.”

It was clear that the Fed’s crystal ball had failed. 

You see, the Fed is not good at seeing patterns as they develop.

The economists and experts within the halls of the Fed tend to measure the economy from a limited vantage point.

That means they typically exaggerate and are reactionary in their policies while ignoring the obvious as it’s unfolding.

Things like creeping inflation or housing bubbles get overlooked. 

But ignoring financial realities can lead to drastic consequences. History shows us this.

Take the lead-up to the financial crisis of 2008, for example.

Former Fed chair – and now Nobel Prize-winner – Ben Bernanke paid no attention to the budding housing and banking crisis.

In 2007, he said:

We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.

Clearly, Bernanke was wrong then.

And clearly, Powell has errored now.

Because when the financial system and the global economy are on the line…

Understanding what’s happening on Main Street matters when making policy decisions.

Party Like It’s 1997

And that brings us back to the 1997 holiday season. There was a similar storyline at the end of that year, too. 

The real economy was increasingly strained around the world. Especially in emerging market countries whose currencies were reeling relative to the U.S dollar.

As was the case in many industries, holiday gatherings were a staple of creating good spirit. Wall Street would go all out.

Think chocolate fountains, ice sculptures, and glitz and glam.

End-of-the-year galas and extravagance were surely excessive but a part of the banking culture.

In London, one could go from appetizers at the Merrill Lynch party to drinks at the Credit Suisse gathering to the Paribas party for a nightcap.

But not in 1997. Instead, we were looking at small pub get-togethers and then home for a meal.

Banks around the world were cutting back. They were looking to protect themselves from additional losses.

This was in the wake of an Asian currency crisis that wreaked havoc on the markets and the profitability of banks.

JPMorgan saw its own earnings drop by 35% that year alone.

So, Why Does This Matter?

The Asian currency crisis was largely caused by an overheating in property and stock market values… while the Fed ignored the growing risks and allowed the dollar to strengthen.

The boom of the dollar hurt other currencies and their respective economies.

As the San Francisco Fed noted in 2011 with its post-crisis analysis: “Reduced oversight and high leverage tend to reduce transparency” and negatively impact market resiliency.

In Fed speak, that’s as close to admitting they were caught off guard as it gets.

So, why does this matter? Because history shows us how economies were slowing at a time when a strong dollar intensified global market turbulence.

If all of this rings a bell, it’s because similar elements are at play right now.

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