Rates Cuts Seemingly Imminent After Fed Officials Utter The "R Word" For First Time

Former New York Federal Reserve President William Dudley, who also served as the VP of the Federal Open Market Committee, wrote in a Bloomberg Opinion column Wednesday that the Fed should consider a rate cut as soon as its next meeting scheduled for July 30 and 31. The economist, until recently, was a strong supporter of the Fed keeping rates higher for longer, but now believes inflationary pressures have subsided meaningfully to the point that the American economy is headed toward a recession. Dudley believes that Fed officials are misreading the signals given by the cooling down labor market. He is not alone in believing a rate cut is necessary. Goldman Sachs Chief Economist Jan Hatzius also believes a rate cut is needed as soon as the coming week to ensure robust economic growth.

The Devil In The Details

Fed officials were briefly worried about a recession in early 2023 when the failure of Silicon Valley Bank threatened to trigger a run on the bank. Fed minutes from the April 2023 meeting show that some FOMC participants were worried about a recession but the economy bounced back sharply in the following months, enabling the Fed to keep rates steady.

Before that, Fed officials were worried about a major economic recession back in 2020 March when WHO declared Covid-19 as a pandemic. The Fed acted swiftly to cut the Fed funds rate by 50 basis points on March 3, 2020, followed by a record 100-basis point cut on March 15, bringing the policy rate to a range of 0% to 0.25%. Fed fears of a recession proved to be correct with the U.S. economy entering a recession in Q2 2020 with the GDP contracting more than 30%. The unemployment level also hit a high of almost 15% in April 2020.

Fed’s swift response, however, saved the economy from a prolonged recession, and the U.S. economy started showing initial signs of recovery in the fourth quarter of 2020. After declining 2.8% in 2020, the U.S. economy grew 5.9% in 2021 on the back of expansionary monetary policy decisions.

Zooming Out

The stock market rally that began last year has boosted investor confidence but there is every chance the U.S. economy might enter a recession sooner than some investors believe. According to the Fed’s recession probability model, there is a 56% chance of a recession within the next 12 months. Inflation, despite slowing down, remains elevated, prompting the Fed to hold rates unchanged at a time when the job market is cooling, which may lead to a strong, sudden decline in discretionary spending. Morgan Stanley economists, who projected an 80% probability of a soft landing at the beginning of this year, are now projecting a 50% probability of a soft landing while the risk of a hard landing where the economy contracts sharply has risen to 25%. If this risk materializes, global trade will slow down sharply, capital markets will turn substantially volatile, and supply chains will be disrupted.