On Monday, August 24th, the focus of the financial markets is shifting from the traditional interest rate cycle to the more complex issues of asset prices and the wealth effect. Market discussions reveal a clear divergence within the US economy: on the one hand, financial asset values remain high, leading to a continued increase in the wealth of some asset holders; on the other hand, the job market is experiencing weakening momentum, putting pressure on labor income growth. This structural change is impacting the inflation formation mechanism and posing new challenges to the Federal Reserve's past policy framework, which relied heavily on interest rate adjustments. From a traditional macroeconomic perspective, inflation is primarily driven by overheated demand, rising wages, and supply constraints. However, in the current environment, some price pressures stem more from the wealth effect resulting from rising asset prices—that is, increased asset values enhance the consumption power of certain groups and further boost demand in the service sector. Areas highly correlated with wealth levels, such as housing, tourism, and catering, have become important windows for observing inflation stickiness.

The wealth effect alters the transmission path of inflation, and economic structural differentiation becomes the core variable.

For decades, a key method central banks have controlled inflation is by influencing financing costs to alter consumption and investment behavior. When interest rates rise, corporate financing costs increase, household loan burdens increase, and demand is typically suppressed. However, the current economic environment presents new changes, namely, a more complex relationship between financial asset prices and real income. Some analysts believe the US economy exhibits a "K-shaped divergence." On one side are groups with substantial financial assets, whose wealth is driven by rising asset prices; on the other side are groups primarily reliant on wage income, facing greater pressure from rising living costs. The declining proportion of wage income in the overall economy, coupled with persistently high household net wealth, is increasing the importance of the wealth effect in consumption. This structure implies that simply raising short-term interest rates may not fully resolve inflationary pressures from asset prices. This is because while high interest rates can limit credit expansion, they may not quickly impact the existing asset wealth effect. If financial markets remain highly liquid and asset prices remain high, some consumer demand may remain resilient, making it difficult for service price pressures to decline rapidly. Therefore, the current market focus has shifted from "whether interest rates are high enough" to "whether financial conditions have truly tightened."

The effectiveness of interest rate policy faces challenges, and the Federal Reserve's toolbox needs to be reassessed.

Traditional monetary policy relies primarily on adjustments to the federal funds rate. However, in the current environment, the Federal Reserve faces a new challenge: while interest rates may already be limiting the real economy, financial markets remain highly active. Some argue that asset markets are significantly more sensitive to liquidity than the real economy. Financial asset valuations, corporate financing, and investment expectations may be more quickly influenced by the monetary environment, while real-economy variables such as employment and consumption have a longer transmission cycle. This leads to a degree of complexity in monetary policy. Further increases in interest rates could increase pressure on the real economy; however, if financial conditions remain loose, it could prolong the inflationary impact of asset prices. The Fed's balance sheet policy is therefore under scrutiny. Current data shows that the Fed's assets remain at a high level, with securities holdings exceeding $6 trillion. Some believe that reducing the balance sheet can be an important way to adjust the financial environment, influencing asset price expectations by reducing market liquidity. However, a balance needs to be struck between the pace of balance sheet reduction, financial market stability, and banking system liquidity. Balance sheet adjustments are not simply about reducing size; they involve the operational mechanisms of the financial system. Too rapid a pace could increase market volatility; too slow a pace could weaken the policy transmission effect.

The AI investment boom brings new risks, and the role of financial regulators is being strengthened.

In recent years, investment in artificial intelligence (AI) has expanded rapidly, becoming a major theme in the capital market. A large influx of funds into related industrial chains has boosted corporate financing activities and raised market expectations for future improvements in production efficiency. However, some traders are beginning to focus on the financing structure behind AI investments. If a large amount of capital enters high-risk projects through non-traditional financial channels, it may reduce regulators' ability to identify accumulated risks. From a financial stability perspective, the issue is not the development of a particular industry, but whether capital allocation adequately reflects risk. If asset prices rise significantly faster than profit realization, the market may develop a strong expectation cycle. The Federal Reserve may focus more on leverage levels, credit quality, and asset price changes in the financial system, rather than solely on traditional inflation indicators. This means the importance of financial regulatory tools is increasing. Compared to simply adjusting interest rates, influencing market expectations through capital regulation, liquidity management, and policy communication may become an important supplement to future monetary policy.

The market is focused on policy communication; the Federal Reserve needs to redefine its expectations of a "financial safety net."

For many years, a general expectation has formed in the market that the Federal Reserve might use liquidity tools to stabilize the market when significant stress occurs in financial markets. This expectation has, to some extent, reduced market risk premiums and encouraged funds to allocate more actively to risky assets. However, if the market consistently believes that policymakers will limit the decline in asset prices, it could lead to a decrease in risk pricing and push investors to take on more risk. One of the important tasks currently facing the Federal Reserve is to rebuild the market's understanding of policy boundaries. Policy communication not only affects short-term market volatility but also long-term asset allocation logic. Future market focus may concentrate on three aspects: First, whether the rate of inflation decline aligns with policy objectives. Second, whether changes in the labor market will further impact economic growth. Third, how the Federal Reserve will balance asset price stability with financial market efficiency.