A Federal Reserve Crisis of Confidence Threatens the Very Fabric of Wall Street -- and Investors May Pay the Price

Since 2019, investors have been privy to a bit of stock market history. The benchmark S&P 500 (SNPINDEX: ^GSPC) has gained at least 16% for three consecutive years on only three occasions spanning 98 years. It's been done twice over the previous seven years (2019-2021 and 2023-2025).

The ageless Dow Jones Industrial Average (DJINDICES: ^DJI) and growth stock-dominated Nasdaq Composite (NASDAQINDEX: ^IXIC) haven't been slouches, either. Both have soared to several record-closing highs.

While game-changing technology trends (artificial intelligence and quantum computing), record share buybacks, and better-than-expected corporate earnings have provided a lift for the Dow, S&P 500, and Nasdaq Composite, headwinds are always present that threaten to pull the rug out from beneath Wall Street and investors. Sometimes, these headwinds come from sources you'd least expect, such as America's foremost financial institution, the Federal Reserve.

Fed Chair Jerome Powell delivering remarks. Image source: Official Federal Reserve Photo.

A crisis of confidence may be mounting on Wall Street, courtesy of the Fed

The Federal Reserve is one of the pillars of the U.S. economy and stock market. Its job is to use monetary policy to maximize employment and stabilize prices. It's a pretty straightforward mission, but it's easier said than done.

The Federal Open Market Committee (FOMC) -- the 12-person body, including Fed Chair Jerome Powell, responsible for setting the nation's monetary policy -- typically adjusts the federal funds target rate to effect change. This is the overnight lending rate between financial institutions.

Increasing the target rate is akin to pumping the brakes on the U.S. economy and is often used to tame rising/high inflation. Meanwhile, reducing the federal funds target rate encourages lending and is expected to bolster economic activity and hiring.

Given that the FOMC is a data-driven entity, and the economic data it bases its decisions on is backward-looking, it's not uncommon for the Fed to be behind the curve when the economy, inflation rate, or unemployment rate begins to shift. While investors have historically tolerated this tardiness, the same can't be said when members of the FOMC aren't on the same page.

For much of Jerome Powell's term as Fed chair, dissenting opinions among FOMC members were minimal. But this hasn't been the case since the midpoint of 2025. Each of the last five FOMC meetings has had at least one dissent (i.e., either a call for no rate cut or the belief that rate cuts should have been more aggressive).

Anna is correct below when she says:
"I have not seen a meeting with so much contradictions."
---
This meeting was a mess.

See the labels in the dot plot below.

One member of the FOMC thinks the Fed is going to HIKE rates this year. One (Stephen Miran) thinks it is going to cut... https://t.co/TRUQmD5I2E pic.twitter.com/qPlJGL57ln

-- Jim Bianco (@biancoresearch) September 17, 2025

More importantly, the October and December FOMC meetings featured dissents in opposite directions. Both meetings resulted in the federal funds target rate being lowered by 25 basis points. But the FOMC meeting statements showed at least one member favored no reduction, while another pushed for a 50-basis-point cut.

Division within the FOMC is worrisome. Dissents in opposite directions are historic. It's something we've only witnessed in three FOMC meetings over the last 36 years -- and it's occurred twice since late October. The perception that the Fed lacks a unified approach to reach its monetary policy goals is a potential recipe for a crisis of confidence on Wall Street.

Jerome Powell speaking with President Donald Trump. Image source: Official White House Photo by Daniel Torok.

Powell's term ending will magnify uncertainty

Unfortunately, a historic level of division at America's foremost financial institution is just part of the problem that Wall Street and investors have to digest. In just three months, on May 15, Jerome Powell's term as Fed chair will end.

To be clear, it's been known for some time that Powell's tenure as Fed chair was winding down. Since taking office for his second, non-consecutive term, President Donald Trump has been critical of Powell and the FOMC for not being more aggressive in lowering interest rates. It became clear last year that Powell would not be continuing as Fed chair beyond mid-May 2026.

But changing the puzzle pieces at the nation's central bank always raises questions.

On Jan. 30, Trump nominated former Fed Governor Kevin Warsh to succeed Jerome Powell as the next Fed chair. Warsh was previously on the Board of Governors of the Federal Reserve from Feb. 24, 2006, to March 31, 2011, meaning he played a role in the central bank navigating what was arguably its most challenging environment (the financial crisis) since the Great Depression.

However, several question marks surround Warsh's nomination. For one, it's unclear if he'll have the necessary votes to clear the Senate Banking Committee and/or a full Senate vote. If Warsh doesn't clear these hurdles, we're back to square one.

If Warsh does receive the necessary votes, the attention then turns to his desire to deleverage the Fed's balance sheet, which holds close $6.6 trillion in assets (e.g., long-term U.S. Treasuries and mortgage-backed securities). Warsh has long believed that the central bank should be more of a spectator than an active market participant. Reducing the assets held on its balance sheet would be a means to that end.

Yet it may not be this simple. Since bond prices and bond yields have an inverse relationship, any attempt to offload the long-term Treasuries held on the central bank's balance sheet could increase long-term yields and interest rates. This poses a potential threat to mortgage rates and borrowing costs.

Amid this historic division and the uncertainties surrounding the Warsh nomination, we have the second-priciest stock market in history, dating back to January 1871. At this level, there isn't much wiggle room when it comes to the level of uncertainty Wall Street and investors are willing to tolerate.

A crisis of confidence is brewing at the Fed, and it's investors who may ultimately pay the price.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.