It may already be too late for the Fed to stop a recession, former central bank president says

"Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk," Bill Dudley wrote.

• It may be too late for interest-rate cuts to stop a recession, former Fed president Bill Dudley wrote for Bloomberg.
• He called for the central bank to start cutting rates this month.
• With rates slowing down the economy, unemployment will rise, triggering a recession indicator, he cautioned.

Cutting interest rates now might no longer be enough to stop a recession, Bill Dudley wrote for Bloomberg, cautioning that delaying cuts for another month will only aggravate the situation.

"Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk," the former New York Federal Reserve President said.

Cooling inflation and labor data have convinced markets that the Fed will start slashing rates by September. But to Dudley, even this is too late, and central bankers would do better to pivot rates at next week's policy meeting.

However, few investors indicate this is likely to happen, and the Fed itself has heavily emphasized a preference to wait. According to the CME FedWatch Tool, the odds of a July rate cut are just 7% right now, compared to a near-consensus 88% for September.

"If we loosen policy too late or too little, we could hurt economic activity," Jerome Powell told a Senate Committee in early July.

While Dudley, too, subscribed to the idea that rates should stay higher-for-longer until the Fed achieves its target inflation rate of 2%, he noted that macro-conditions have taken a turn for the worse.

Where the Fed's monetary tightening appeared insufficient over past years due to high consumer spending and an investing boom, Dudley cited that its impact is now becoming quickly apparent.

Pandemic-era savings are depleting, housing construction is slumping, and momentum from government-led investing initiatives — such as in infrastructure and semiconductors — is fading, he said.

According to Dudley, this slowdown points to fewer jobs down the road, and an uptick in unemployment could set off a near-certain recession indicator: the Sahm Rule.

The model tracks unemployment's three-month average rate, and flashes red when this metric increases by 0.5% from a 12-month low.

"Most troubling, the three-month average unemployment rate is up 0.43 percentage point from its low point in the prior 12 months — very close to the 0.5 threshold that, as identified by the Sahm Rule, has invariably signaled a US recession," Dudley said.

Despite this, Dudley suggested that the Fed might not be as concerned about breaching the Sahm Rule as it should be. Those indifferent to it have explained unemployment's rise as the consequence of a rapidly growing labor force, and not due to rising layoffs, he said.

But even if this were the case, it doesn't make the indicator any less perceptive, Dudley added: the rule accurately predicted recessions in the 1970s, at a time when the labor force was also rising quickly.

Last month, Claudia Sahm, the rule's creator, also called on the Fed to pay closer attention to it.

"My baseline is not recession," she said. "But it's a real risk, and I do not understand why the Fed is pushing that risk. I'm not sure what they're waiting for."

According to Dudley, there are two other reasons the Fed may be waiting for September to cut rates.

He suggested that central bankers don't want to make a mistake by declaring victory over inflation too soon, given last year's moderations in inflation proved temporary. Otherwise, Dudley suspects that Fed Chairman Jerome Powell is seeking broader support for cutting.