How has the US stock market performed during previous Federal Reserve transitions?

On May 15, Powell officially stepped down as the Chair of the Federal Reserve, and Warsh took over the oath of office. The core concern for the market is: with the change in leadership at the Fed, how will U.S. stocks perform?

Huafu Securities pointed out in its latest report that investors need to be wary of the deceptive calm during the ‘first month of transition.’ Historical experience shows that the first month under a new Federal Reserve Chair typically sees relatively stable performance in U.S. stocks, even slightly better than the historical average.

However, the true market variables often emerge three to six months after the transition. As the new policy framework is gradually priced in by the market, the average maximum drawdowns for U.S. stocks over three and six months reach -10.13% and -13.14%, respectively, significantly raising medium-term volatility risks.

Meanwhile, the shift in policy style is reshaping asset pricing logic. Warsh explicitly stated during his confirmation hearing that he would abandon the forward guidance framework of ‘excessive communication’ characteristic of the Bernanke, Yellen, and Powell eras. This means the Federal Reserve will no longer act as the market’s ‘protector,’ and asset prices will become much more sensitive to economic data and meeting resolutions.

At the operational level, Warsh plans to introduce trimmed mean PCE as a new inflation measure and, constrained by the current system size of approximately $3 trillion in reserves, may proactively slow down the pace of quantitative tightening (QT). For investors, the next six months will require preparation for higher expected volatility and more pronounced asset repricing.

The ‘honeymoon period’ in the early stages of the transition versus the ‘risk amplifier’ in the medium term

Historical data indicates that the impact of a Federal Reserve Chair transition on U.S. stocks exhibits a clear ‘limited short-term, amplified medium-term’ pattern. Markets often over-worry about unknown policy shifts, but experiences since 1970 reveal a counterintuitive phenomenon: the first month following a transition does not plunge U.S. stocks into turmoil; instead, it enters a relatively safe ‘observation period.’

Specifically, one month after the transition, the average increase in the S&P 500 Index was 1.81%, significantly higher than the overall historical average of 0.80%; the corresponding average maximum drawdown was only -2.91%, better than the historical overall figure of -3.95%. This is mainly because the incoming chair tends to maintain the predecessor’s policy framework or communication tone in the initial phase, thus providing short-term certainty to the market.

However, real risks gradually emerge in medium-term pricing. As the FOMC’s new policy path, changes in economic data, and the substantive influence of the new chair’s communication style take hold, U.S. stocks will face a significant risk amplification window:

Three-month horizon: The average gain/loss of the S&P 500 drops from the historical norm of +2.28% to -1.74%; the average maximum drawdown widens to -10.13%, deepening by 2.92 percentage points compared to the historical norm.

Six-month horizon: The average increase further narrowed to 1.17%, significantly lower than the historical norm of +4.63%; the average maximum drawdown deepened to -13.14%.

In summary, the impact of the Federal Reserve leadership transition on the U.S. stock market is not an immediate eruption but rather a gradually intensifying process. Investors need to remain highly vigilant about volatility risks over a three- to six-month horizon beneath the initially calm surface following the transition.

Historical Review: Macroeconomic Cycles and Policy Continuity Dictate Market Fate

A review of Federal Reserve leadership transitions since 1970 shows that the ultimate market direction was not determined by the change in personnel itself, but rather depended on the inflation levels, valuation positions, and whether the new chair continued the existing policy framework at the time. The macroeconomic backdrop of each transition has been the key variable determining the intensity of fluctuations in the U.S. stock market.

When Burns took office, U.S. inflation was high (CPI around 6.2%) and unemployment stood at 4%. Under political pressure from Nixon, he reduced the effective federal funds rate from 5.75% to 3.25%, temporarily fueling the ‘Nifty Fifty’ rally. However, this move completely undermined inflation expectations, sowing the seeds for subsequent stagflation.

After Miller assumed office, the U.S. stock market rose 18.68% over six months. However, this rally was built on the false prosperity of negative real interest rates, with inflation remaining unchecked. When Miller took office, inflation was already at higher levels and continuing to rise, yet he did not shift to a tightening stance, causing inflation expectations to spiral further out of control.

Faced with runaway inflation, Volcker pushed interest rates to extreme levels near 20%, resulting in a six-month maximum drawdown of -10.25% for the U.S. stock market. However, this short-term pain secured fundamental control over inflation, eventually bringing CPI down to the 3%-4% range.

Greenspan initially maintained a tightening stance upon taking office, compounded by high equity valuations and the prevalence of program trading, directly triggering ‘Black Monday’—with the market experiencing a maximum drawdown of -5.16% within his first 60 days. This shock forced him to quickly pivot, cutting interest rates from 7% to 5.5% in the short term to stabilize the market.

When Bernanke took office, the economic fundamentals were relatively stable, continuing the path of interest rate hikes, with the maximum drawdown over three months being only -2.16%. At the time Yellen took over, CPI was just 1.1%, and the Federal Reserve maintained a zero-interest-rate policy, allowing the market to steadily rise amid a moderate recovery, with a cumulative increase of 8% over 180 days. Powell took over in the later stages of the rate hike cycle, and in 2018, against the backdrop of trade frictions, continued with four rate hikes to bring the range to 2.25%-2.5%, leading to significant pressure on U.S. equities in the early stages of his tenure.

Historical experience shows that what truly determines market direction is the position in the cycle and policy choices behind leadership transitions, rather than the transitions themselves.

Warsh’s Governance Blueprint: Reshaping the Inflation Narrative and Ending ‘Excessive Communication’

If Warsh leads the Federal Reserve, he may reshape the central bank’s communication mechanism, reduce forward guidance, and leverage the ‘trimmed mean PCE’ and AI productivity narrative to create policy space for interest rate cuts.

At the Senate hearing, Warsh demonstrated a clear posture of reflection and reform, directly pointing out the significant policy failure of runaway inflation from 2021 to 2022. On the operational level, the market needs to pay close attention to adjustments in his communication mechanisms. Warsh explicitly opposes the pre-disclosure of interest rate paths, believing that ‘excessive communication’ constrains policy flexibility. This suggests that the expectation management model that has persisted from Bernanke, through Yellen, to Powell for nearly fifteen years might come to an end. Without the protection of forward guidance, risk assets will exhibit amplified volatility in response to economic data and FOMC meeting outcomes.

Regarding the logic of interest rate cuts, Warsh did not commit to rapid reductions but proposed two potential easing pivots:

AI Productivity Narrative: Believes that efficiency gains brought by artificial intelligence can provide a basis for interest rate cuts in the long term.

New Inflation Measurement Framework: Specifically mentions the ‘trimmed mean PCE’ compiled by the Dallas Fed — excluding the bottom 24% and top 31% of weights. Under current tariff and localized commodity shocks, this indicator is significantly lower than core PCE. If its weight in decision-making increases, the Fed could construct a narrative of ‘potential inflation having receded,’ thereby creating room for interest rate cuts.

On balance sheet reduction, Warsh advocates for coordinated progress with the Treasury, proceeding slowly and cautiously. However, current liquidity conditions do not support aggressive operations. The current scale of bank reserves is about $3 trillion, while the ONRRP buffer is narrowing. Referring to the 2017-2019 balance sheet reduction cycle, when reserves dropped to approximately $1.4 trillion, it triggered a repo market crisis. Considering stricter current regulations and banks’ higher intrinsic demand for reserves, the actual compressible liquidity space is limited. Therefore, balance sheet reduction under Warsh’s leadership is more likely to follow a compromise path of ‘slower, shallower, and delayed.’

Editor/Lambor