Is the Fed About to Ignite a 1999-Style Market Melt-Up?
The Fed is set to slash rates with stocks at record highs, pouring fuel on the AI bubble and potentially sparking a repeat of the dot-com mania.
In recent weeks, I’ve published a series of widely read reports on rare volatility squeezes appearing across at least 15 major assets, including stocks, commodities, currencies, and Treasuries. These are not isolated or random developments but part of a larger underlying pattern. The markets are now caught in a massive, collective volatility squeeze as they await clarity on several critical economic fronts. In my view, these squeezes represent the calm before the storm, soon to be followed by a powerful surge in volatility.
As a refresher, a volatility squeeze is a period of unusually low volatility that leads to a surge in volatility, known as a volatility breakout. These squeezes are important to watch because they frequently precede large market moves. If you haven’t already, I recommend reading my recent explanation of volatility squeezes to better understand the context of today’s report.
In today’s report, I want to advance the very realistic theory that the Federal Reserve is on the verge of making a major policy mistake that could ignite another market melt-up reminiscent of the 1999 dot-com bubble. This builds on what I wrote a few days ago about the extremely rare volatility squeeze now forming in the U.S. stock market. At that time, I argued that the momentum was more likely to be to the upside, given the prevailing uptrend and the fact that the S&P 500, Nasdaq 100, and Dow had all just surged above major resistance levels, which is a powerful sign of strength.
That stock market report drew strong interest and sparked lively discussions and debates in the comments about how this volatility squeeze might unfold. Those conversations led me to think more deeply about the setup, including both the arguments for a sharp continuation higher as well as the case for a sudden reversal lower.
Then last night I came across a post from The Kobeissi Letter financial newsletter asserting that “the Fed is about to add rocket fuel to the fire.” It immediately made me think of the volatility squeeze forming in U.S. stock indices and of the internal debate I have been having, along with discussions with subscribers, about how this setup is likely to play out.
After reading that post, it hit me that the Fed may be about to supercharge today’s stock market bubble, just as it did during the dot-com era of 1998 and 1999. That may be exactly what the current volatility squeeze is foreshadowing. Moreover, there are actually several striking parallels between then and now, with artificial intelligence (AI) taking on the role once played by the internet boom.
To better understand this theory, we need to revisit the late-1990s economy, stock market, and U.S. monetary policy. After a short setback during the early 1990s recession, the U.S. economy and equities surged on the strength of the rapidly expanding information technology boom, which continued through the rest of the decade.
By 1996, stock market gains were so strong that in December of that year, Federal Reserve Chairman Alan Greenspan used the now-famous phrase “irrational exuberance” in a speech to question whether valuations were being driven more by psychology than by fundamentals. Although he is often criticized because the bull market continued for another three years, in fairness he was urging caution rather than calling the top, and in my view he was right to do so.
Then in 1997 and 1998, global financial markets were shaken by the Asian financial crisis, which triggered a broad loss of confidence in emerging markets. Investors pulled funds from riskier countries, including Russia, ultimately leading to Russia’s debt default and ruble devaluation.
These shocks then dealt a heavy blow to Long-Term Capital Management (LTCM), a highly leveraged hedge fund with over $100 billion in assets, which suffered catastrophic losses from its exposure to emerging markets and interest rate spreads. All three of these events deeply unsettled global financial markets, driving the S&P 500 down nearly 20% from its July 1998 peak to its October low.
In response to the escalating turmoil and the risk of systemic contagion, the New York Fed organized a $3.6 billion private-sector bailout of LTCM with the participation of major Wall Street banks. To further restore confidence, the Fed cut the federal funds rate three times between September and November, lowering it from 5.5% to 4.75% (75 basis points in total).
The bailout and subsequent rate cuts flooded the markets with liquidity, restored confidence in credit markets, and fueled a sharp rebound in stocks heading into 1999. This set the stage for the final blow-off phase of the dot-com bubble, as the tech boom, which was largely untouched by the 1998 emerging market and credit turmoil, took off once stimulus hit. Often when one part of the economy is struggling while another remains strong, new stimulus pushes the stronger sector to unsustainable extremes. I believe that is exactly what may soon happen with the AI bubble, as I will explain later in this report.
The chart below of the tech-heavy Nasdaq 100 shows how the Fed’s late-1998 rate cuts ignited the mania phase of the dot-com bubble. Over the next year and a half, the index surged nearly fourfold, rising about 280%. That frenzy fueled a wave of notorious dot-com IPOs such as Pets.com, Buy.com, Priceline.com, Webvan, eToys, and Akamai Technologies. These offerings became infamous for their staggering first-day pops—often 300% to 700%—along with sky-high valuations despite no profits or clear business models. In many cases, they were driven more by buzzwords like “internet,” “eyeballs,” and the “new economy” than by fundamentals.
