When the assumption of monetary policy meets market reality

Market observers attentive to the Federal Reserve’s moves know: something has changed in recent months, and most are simply following the scripts as if nothing has happened. The issue is not straightforward. If the Federal Reserve truly hands over decision-making to Christopher Waller, markets will not just be dealing with a technical monetary policy adjustment. They will face a resilience test on a scale that does not expose weaknesses overnight but reveals them brutally over time.

Waller’s straightforward logic and its fragile foundations

Waller’s view sounds coherent on paper. AI would boost overall economic productivity. More robust productivity should cool inflation pressures. With inflation under control, aggressive balance sheet reduction would gain enough political cover — trillions quietly absorbed through non-renewal of maturing assets. Rate cuts, then, would serve as the final “soft landing” of the cycle.

On the surface, it seems almost elegant. But this core assumption — that AI-driven productivity gains would come smoothly, uniformly, and quickly enough — carries a fragility that deserves attention. Historically, policymakers like Jerome Powell understood this vulnerability, which is why they always acted cautiously. Not out of lack of conviction, but because they recognized how close the system already operated to the edge of equilibrium.

The cascade effect: liquidity, rates, and confidence

Removing liquidity on such a massive scale does not happen in a vacuum. Draining credit from the system pushes real interest rates higher — whether markets like it or not. Higher real rates first pressure U.S. Treasury bonds. Bonds begin to wobble. Yields spike. Risk spreads widen across all segments. Confidence fractures.

Simultaneously, rate cuts weaken the dollar not gradually but structurally. And when bonds are being sold while the currency destabilizes, stocks do not get a free pass. The result is what experts call a downward resonance — stocks, bonds, and currency all under joint pressure. It is precisely the scenario most portfolios are not built to withstand.

When the assumption fails: the true cost of reversal

The plan assumes a perfect sequencing of events. If this assumption slips — even slightly — the “perfect script” becomes a dead end. And here lies the real risk: when policymakers are forced to backtrack midstream, the damage is not just temporary price drops. It is the loss of institutional credibility.

A forced policy reversal signals that the system was not as solid as promised. Feedback cycles take over. Liquidity dries up. Volatility feeds on itself. Markets stop trusting the script.

That is why those monitoring the situation should ask honest questions: Which assets break first if liquidity truly tightens? Where is leverage hiding in portfolios? And what do you own that only works in a “perfect” environment? These answers determine who survives the upcoming stress tests.