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In 1917, after witnessing human’s folly during World War I, Prof. Joseph Jastrow explored The Psychology of Conviction.’ What makes people do what they do?

In this century-old paper, there is no reliance on expensive, peer-reviewed experiments. There is no big data. There is no neuroscientific analysis. The essay, a masterpiece of English literature, solely relies on thoughtful human behavior observations.

Prof. Jastrow first establishes that ‘to reach conviction implies an impulse toward thinking.’ That impulse stems from the need to make decisions following a rational facts-seeking process. Soon, however, two important factors kick in, namely emotion: ‘Fundamentally, beliefs are formed and held because they satisfy, because they minister to some deep psychological craving;’ and convention: ‘Equally significant is the sharing of such beliefs with others, which is their indispensable social reinforcement.’

Conviction powers the financial markets. Take the dynamics around the Federal Open Market Committee meetings. In December, the Fed is said to have pivoted from a dovish to a hawkish stance. To crush any doubts, Mr. Powell double-downed last week. Over a few weeks only, inflation, a non-issue throughout 2021, became a significant issue for the Fed and the rest of the world.

There are various interpretations of this event. They can all be traced to the psychology of conviction.

The first is that Mr. Powell, who held a dovish view about inflation through the health crisis, was confronted with a new set of facts that led to a shift in perspective. The Fed’s data-dependent conviction about inflationary trends changed as the data changed.

The second and less generous interpretation is that the Fed is rarely convinced of anything. In fact, it barely knows what it is doing. But it must fulfill a critical leadership role in the financial markets: projecting certainty through conviction. Consequently, the Fed must be either dovish or hawkish. Anything in between would be confusing and breed economic and financial instability. This explains why a change of tack in monetary policy cannot be smoothed.

The third one is that the Fed did not pivot at all. Its position followed a gradual and natural evolution. But economists and market participants crave certainty. To satisfy their needs, they attribute conviction to the Fed. The Fed is deemed to be either dovish or hawkish. That is why a slight change of tone in Mr. Powell’s voice can result in a dramatic tilt in the interpretation of his position.

Beyond these emotions comes the convention-led contagion amongst market participants. Suddenly, a majority shares the same conviction, as observed in this month’s dramatic equity market moves, including a stunning rotation from growth to value. Even the ECB, until now firmly on the dovish side, had its ‘hawkish pivot’ on Thursday.

Conviction is a powerful force. Whether built or faked, it exerts influence on the financial markets, management, policymaking, or politics. But the possibility to acquire it on the cheap in a post-truth world makes it a unique weapon of mass (value) destruction.

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