Bill Dudley, former New York Fed president, has shifted his stance, now advocating for rate cuts due to recent economic developments.

Despite this, he believes the Fed won’t cut rates before September to avoid market panic and the risk of inflation resurgence.

Dudley also highlights concerns about rising unemployment, which he argues could lead to reduced spending and investment.

The market expects a rate cut in September, with tools like the FedWatch Tool showing a high probability of such a move.

Dudley warns that delaying could make economic recovery more challenging.

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Bill Dudley, former president of the Federal Reserve Bank of New York, spoke in late July before the market bloodbath happened last week.

He was known as a rooter for a higher-for-longer stance for a while but after the recent developments, he said the facts have changed and so has his opinion and the Fed needs to cut rates now.

It’s easier said than done, especially for a person with no authority and Dudley knows that. That’s why he also said the Fed wouldn’t cut rates in July’s meeting. He listed three reasons for that.

First, the Fed doesn’t want to be misled by a temporary slowdown in inflation as happened in late 2023. Because it will be much more difficult to fight inflation once the Fed lowers interest rates.

Second, the Fed has been signaling rate cuts in September for a long time. Therefore, the market expects that.

A rate cut before September would cause panic among investors and spread recessionary fears.

Lastly, Dudley argued that the Fed officials are not particularly worried about the unemployment rate possibly breaching the Sahm Rule, a recession indicator with an impressive track record.

Dudley thinks the Fed doesn’t care about the unemployment rise because they believe it is driven by labor force growth rather than layoffs.

As a counterargument, he pointed out the success of the Sahm Rule in predicting recessions in the 1970s when we had seen rapid labor force expansion.

Dudley’s statement was before the Fed’s meeting in July and the announcement of the most recent unemployment data.

To his point, the Fed left rates unchanged. And the recent unemployment rate of 4.3% showed that we crossed the Sahm Rule recession indicator.

The market reacted accordingly as the S&P 500 fell 7% in the two days following the unemployment announcement.

Nasdaq and Russell 2000 also joined the party with each falling 10% in the same period.

And the rumors of an emergency Fed meeting and a possible rate cut have spread around the world.

Dudley was mainly worried about the slowdown in employment… and how weak employment would make people cut back on spending which would eventually force businesses to reduce investments leading to even weaker employment.

In addition, he argued that the inflation data is coming back to safe levels for good.

The Fed is certainly aware of these things and it has been run by qualified people who have access to a significant amount of macroeconomic data.

Yet, they have to be careful with both what they say and how they say it.

If the Fed calls for an emergency meeting and cuts rates, that would signal a certain recession risk and would cause more damage to the economy than the benefit of a rate cut.

Now, the market consensus is a rate cut in the next Fed meeting in September and the recent unemployment data makes it only more likely.

We can see this through the FedWatch Tool, created by CME Group, which tries to gauge the market expectations of potential changes in interest rates.

The tool suggests a definite rate cut in September. There is currently a 69% odds of a 50 basis-point cut and a 31% odds of a 25 basis-point cut.

At the moment, it is difficult to know whether we are or will be in a recession or not.

Yet, there is one certain thing: The Fed needs to cut rates in September. Or else, the economy will become much harder to save.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research