The Ghost of the 1979 "Saturday Night Massacre": The Fed's Hesitation on Rate Cuts Reveals Unwillingness to Follow Volcker's Old Path!

The Federal Reserve is facing a historic policy decision—rising oil prices driven by Middle East tensions are influencing current decision-makers’ thinking, reminiscent of the emergency monetary policy action known as the “Saturday Night Massacre” in 1979, which profoundly impacted the current landscape.

As concerns about stagflation intensify, market expectations for a rate cut by the Fed this year have significantly diminished. For example, at the September meeting, the implied probability of a rate cut in futures markets has plummeted from about 90% a month ago to 50%, a trend that has persisted through all of this year’s meetings.

Tonight, the Fed is expected to hold steady. The statements from Chair Powell at the post-meeting press conference and the economic forecasts from Federal Open Market Committee members may further clarify the policy outlook, but markets generally remain pessimistic.

For investors, this means the “bad news is good news” trading logic of the past two years is breaking down. The tech-sensitive Nasdaq 100 is only about 5% below its all-time high but has been nearly flat since mid-February—coinciding with rising Middle East tensions and declining expectations for rate cuts.

The Saturday Night Massacre: How Historical Lessons Shape Current Decisions

In October 1979, then-Fed Chair Paul Volcker convened an emergency meeting to aggressively raise interest rates to combat inflation. This move devastated global stock and bond markets, earning the event the name “Saturday Night Massacre.” The cost was high: the U.S. economy entered a double-dip recession, Treasury yields soared, and President Jimmy Carter’s bid for re-election was jeopardized.

Volcker is a hero whom Powell openly admires. Bond traders generally believe that the Fed is now viewing the situation through the same historical lens: a little prevention now is better than a costly cure later. No policymaker wants to repeat the mistake of resorting to extreme tightening measures like Volcker’s.

The lessons of the 1970s are clear: inflation spiraled out of control amid two energy crises, and the Fed’s delayed and indecisive response ultimately inflicted heavy economic and political costs.

Oil Price Shocks Reshape Rate Cut Paths

Ongoing tensions in the Middle East are transmitting through oil prices into monetary policy.

Bob Elliott, Chief Investment Officer of Unlimited Funds and a seasoned macro hedge fund manager, wrote in a report: “Although many expect the Fed to turn dovish in response to oil shocks, the best-case scenario is to hold steady, and if the situation worsens, the likelihood of rate hikes will increase.”

This sharply contrasts with the market narrative over the past two years. Even with stubborn inflation, investors have been eager to bet on the Fed cutting rates, interpreting weak economic data—including sluggish employment growth over the past year—as a “half-full” reason to keep buying stocks.

Since the Fed resumed easing in September 2024, it has cut rates six times, including a 25 basis point cut in December last year. However, if the blockade of the Strait of Hormuz leads to further supply shortages, this may be the last rate cut for quite some time.

Stock Market Underpricing Policy Shift Risks

Despite the significant decline in rate cut expectations, some market participants still seem to have not fully digested this policy signal. The Nasdaq 100 is only about 5% below its all-time high, indicating that valuations of large tech stocks have not fully priced in the tightening of the interest rate environment.

Apart from sectors benefiting from rising commodity prices, further deterioration of Middle East tensions would be purely negative for stocks. To truly challenge the Fed’s policy stance, the situation would likely need to become “quite ugly.”

Risk Warning and Disclaimer

Markets carry risks; investments should be made cautiously. This article does not constitute personal investment advice and does not consider individual users’ specific investment goals, financial situations, or needs. Users should consider whether any opinions, views, or conclusions herein are suitable for their particular circumstances. Investment is at your own risk.