I changed my mind: the Federal Reserve is going to cut interest rates now!

Just as the market has almost confirmed that the Federal Reserve will stand pat at this month's meeting and start cutting interest rates at the September meeting, former New York Fed President Bill Dudley, who once enjoyed permanent voting rights on the Fed's FOMC, wrote that he has changed his mind and believes the Fed needs to cut rates immediately, rather than waiting until September, which would increase the risk of an economic downturn unnecessarily.

Here is the full text of his column:

I have long been in the "higher for longer" camp, insisting that the Fed must keep short-term rates at current or higher levels to control inflation.

However, the facts have changed, so I have changed my mind. The Fed should cut rates, preferably at next week's policy meeting.

For years, the U.S. economy has remained strong, indicating that the Fed has not done enough to slow economic growth. Generous government measures during the COVID-19 pandemic have provided people and businesses with enough cash to spend. The Biden administration's massive investments in infrastructure, semiconductors, and green transformation have boosted demand. The loose financial environment—especially the soaring stock market—has increased the consumption propensity of wealthy households. Curbing the resulting inflation seems to require the Fed to continue tightening monetary policy.

Now, the Fed's efforts to cool the economy are beginning to show clear effects. Indeed, wealthy households are still consuming due to rising asset prices and refinancing mortgages at historically low long-term rates. But others have generally exhausted the money they saved from the government's massive fiscal transfers, and they are feeling the impact of rising credit card and auto loan rates. The rise in borrowing costs has weakened the economic benefits of building new apartment buildings, and housing construction has stalled. The momentum from Biden's investment initiatives seems to be waning.

Slowing growth in turn means fewer job opportunities. The household employment survey shows that only 195,000 jobs have been added in the past 12 months. The ratio of job openings to unemployed workers is 1.2, returning to pre-COVID levels.

Most concerning is that the three-month average unemployment rate has risen by 0.43 percentage points from the low point of the previous 12 months, very close to the 0.5 threshold set by the Sam rule, which has consistently been effective in predicting economic downturns in the U.S.

Meanwhile, after a series of upside surprises earlier this year, inflation pressures have significantly eased. The Fed's favorite consumer price index—core PCE inflation—rose 2.6% year-on-year in May, just slightly above the central bank's 2% target. Looking at the reported core PCE data, the June PCE data to be released next week may reinforce this trend. In terms of wages, average hourly earnings rose 3.9% year-on-year in June, with the peak in March 2022 approaching 6%.

So, why do Fed officials still strongly suggest that there will be no rate cut at next week's meeting?

I see three reasons. First, the Fed does not want to be fooled again. Last year, the slowdown in inflation was only temporary. This time, due to the low data in the second half of last year, it will be difficult to make more progress in reducing year-on-year inflation performance. Therefore, officials may hesitate to declare victory Secondly, Federal Reserve Chairman Powell may want to wait to build as broad a consensus as possible. Since the market has fully anticipated a rate cut in September, he can argue to the doves that delaying the rate cut would not have any consequences, while seeking more support for a rate cut in September from the hawks.

Thirdly, Federal Reserve officials do not seem particularly concerned about the risk of the unemployment rate quickly surpassing the Sam rule threshold. Their logic is that the rapid growth in labor supply is driving the increase in the unemployment rate, rather than an increase in layoffs. However, this is not convincing: The Sam rule accurately predicted the economic downturn of the 1970s, when the labor market was also rapidly expanding.

Historically, a deteriorating labor market creates a self-reinforcing feedback loop. When jobs become harder to find, households cut back on spending, the economy weakens, businesses reduce investment, leading to layoffs and further spending cuts. That is why after crossing the 0.5 percentage point threshold of the Sam rule, the unemployment rate always increases significantly - from trough to peak, the smallest increase is close to 2 percentage points.

Although it may be too late to ward off an economic downturn through rate cuts now, procrastination at this point unnecessarily increases risks.