Federal Reserve Chairman's Remarks Spark 5% Stock Market Drop

The Federal Reserve Chairman's recent remarks on the U.S. stock market have dampened the bullish sentiment that had been building in the equity markets. On September 23, the Chairman expressed concerns about the high valuation of U.S. stocks, which led to a significant decline in major stock indices. The S&P 500, Nasdaq, and Dow Jones Industrial Average all experienced notable drops following the Chairman's comments.

The Chairman's cautionary remarks came against the backdrop of recent rate cuts and expectations of further reductions by the end of the year. These rate cuts had fueled optimism in the equity markets, with many investors believing that ample liquidity and continued rate cuts would support a prolonged bull market. However, the Chairman's statement highlighted the potential risks associated with overvalued stocks, suggesting that the current market conditions may not be sustainable.

The Chairman's perspective contrasts with the widespread belief that monetary policy can influence market sentiment. While the Federal Reserve has taken steps to ease monetary conditions, the Chairman noted that the current policy rate still has a moderate restrictive effect. This observation implies that there is still room for further adjustment, although the timing and extent of these cuts remain uncertain.

The market's reaction to the Chairman's comments underscores the sensitivity of investors to changes in monetary policy and the potential impact on stock valuations. The sudden shift in sentiment highlights the importance of central bank communications in shaping market expectations and influencing investor behavior. As the Federal Reserve continues to navigate the complexities of the current economic environment, its actions and statements will remain a critical factor in determining the trajectory of the U.S. stock market.

From a global capital flow perspective, the Federal Reserve's monetary policy faces significant challenges. If the expectation of further rate cuts is strengthened, the dollar index is likely to decline, which could weaken the incentive for global capital to flow back to the U.S. This, in turn, could lead to a decrease in investment and economic recession, compounded by the impact of U.S. government tariff policies. The search for the natural interest rate would become more complex and potentially unattainable.

Guiding market expectations may be the underlying intent behind the Chairman's remarks. Given the U.S. debt crisis, the Federal Reserve's passive compliance with the White House's rate cuts has become a market consensus. The impact of the "Big and Beautiful Act," which effectively nullifies the U.S. government's debt ceiling, will gradually materialize by the 2026 fiscal year, eroding the value-anchoring effect of dollar assets. In this context, if the dollar continues to cut rates, global investors may sell dollar assets as a risk-averse strategy. Although the Chairman has only eight months left in office, this is not the outcome they would prefer. Therefore, within the scope of their abilities, influencing the market's judgment on the extent and frequency of future rate cuts, and preventing the market from forming a unanimous one-sided expectation, is likely the Chairman's intention.

Additionally, the Federal Reserve may be signaling to the market that while this rate cut is "reluctant," it will not compromise. Economic data has a lagging effect, so the rise in inflation due to tariffs is only a matter of time. If the fruits of controlling inflation are undermined by tariffs, how will the Federal Reserve explain to the public its commitment to achieving a 2% inflation target? Current evidence suggests that the disruption and reorganization of global supply chains will gradually impact commodity prices over the next six months. For the Federal Reserve, which views controlling inflation as one of its core goals, preventing a rebound in U.S. inflation remains a daunting and complex task. Balancing the demands of the White House with maintaining an independent monetary policy appears to be an increasingly difficult goal to achieve.

In the U.S. economics community, there is a wealth of literature on the interplay between politics and business cycles. Strong economic growth, driven by the rules of U.S. voter politics, is crucial for the incumbent president's chances of re-election. Even if this growth is merely superficial, it can be a significant boost to vote banks if timed correctly. Public data shows that the U.S. debt-to-GDP ratio has exceeded 123%, far surpassing the 90% warning line set by the International Monetary Fund.

This may explain why, since the beginning of the year, the dollar index has been on a continuous decline, the volatility of U.S. Treasury yields has increased, and gold prices have been rising. Under a fragile fiscal system, the U.S. government has been extending its life through methods such as "raising the debt ceiling and strengthening short-term debt issuance to address immediate needs." This has led to a significant increase in the sensitivity of overseas bond markets to U.S. economic data since 2020. Therefore, how to adjust monetary policy to avoid market expectations of a potential U.S. economic recession also requires comprehensive consideration by the Federal Reserve.

For the Federal Reserve, which is in the process of finding the optimal neutral interest rate, using small adjustments in interest rates to observe market reactions is a prudent choice. In a high-interest-rate environment, production and consumption activities that have been suppressed will lay the groundwork for market adjustments. The Federal Reserve also needs to balance "adapting to growth" and "controlling inflation," even as the U.S. government's tariff policies increase the difficulty of this balance.

Overall, to balance the goal of economic growth, a decrease in the federal funds rate is likely in the near future. However, avoiding the formation of a one-sided consensus expectation in the market and preventing this expectation from being frequently priced in is perhaps the biggest challenge facing the Federal Reserve.