The critical moment has arrived! Should the Federal Reserve quickly and significantly cut interest rates?

Chairman and CEO of Caxton Associates, Andrew E. Law, stated that although Federal Reserve Chairman Powell has indicated "now is the time to adjust monetary policy," the extent and speed of rate cuts are still uncertain, and the Fed should quickly and significantly cut rates.

Unlike other central banks, the Fed's dual mandate is price stability and full employment. Given Powell's confidence in inflation moving towards the 2% target, attention is now focused on the outlook for the labor market.

Law mentioned that Powell clearly stated his position at the recent Jackson Hole meeting, saying "we will do everything we can to support a strong labor market." This echoes the tough language used in the past before policy shifts in other central banks, such as former ECB President Draghi's famous 2012 statement that the ECB will "do whatever it takes" to protect the euro.

Adjusting policy in a timely manner to sustain economic expansion is a challenging task. Powell cited economic expansions in 1965, 1984, and 1994 as examples of soft landings. Former Fed Vice Chairman Alan Blinder also described the period of 1999-2000 as a "soft landing." Soft landings are indeed rare, with the alternative being an economic recession.

Although each cycle is unique, the aforementioned soft landings share commonalities in monetary policy. In 1984, rates were cut by over 3 percentage points within four months, reduced by 2.75 percentage points in the first half of 2001, with a 1 percentage point cut in January alone.

1995 stood out, with rates gradually adjusted by 0.75 percentage points over seven months. However, this masked the fact that the expected 1.5 percentage point hike at the end of the cycle did not materialize, and the 5-year Treasury yield dropped by nearly 2 percentage points from the Fed's last hike to the first cut, compared to the current scenario where the 5-year Treasury yield has remained within a narrow range over the past two years, only about 0.5 percentage points lower than the level at the last hike.

Law pointed out that crucially, in each soft landing, the Fed acted before substantial deterioration in the labor market. In these instances, with unemployment rates rising by only 0.1 to 0.3 percentage points, the Fed began cutting rates. Regardless of the reasons for the nearly 1 percentage point increase in this cycle, the precedent is clear.

Other cycles ended in economic recessions. MIT economist Rudi Dornbusch once noted, "No post-World War II economic expansion died of old age; they were all murdered by the Fed".

Law added that another sign necessitating a Fed policy shift is the U.S. real estate market, a key channel through which monetary policy transmits to the economy. Affordability of housing has been destroyed in the current Fed hiking cycle. According to data from the National Association of Realtors, housing affordability has dropped to the lowest level since the mid-1980s **

The current Federal Reserve policy rate is obviously high enough, and the Federal Reserve's favorite core inflation indicator - the PCE price index has dropped from 5.6% to 2.6%. Therefore, considering that the interest rates have not fallen significantly, the current policy rate is more stringent in practical terms. Most members of the Federal Open Market Committee involved in policy-making estimate that the neutral interest rate that neither stimulates nor suppresses the economy is between 2.5% and 3.5%, while the current rate range is between 5.25% and 5.50%.

Some may question whether the Federal Reserve can or should significantly change its stance in the months leading up to the upcoming presidential election. However, Law suggests that the greater concern should be whether the Federal Reserve can afford to persist with inappropriate policies. This would damage its political neutrality.

Law points out that for the Federal Reserve, the worst-case scenario would be if labor market conditions deteriorate significantly, or if financial events related to high policy rates force the Federal Reserve to make further rate adjustments between scheduled policy meetings in the weeks leading up to the election. The September policy meeting is the last opportunity for adjustments before the election.

Law concludes that considering the recognized lag time of 6 to 12 months for monetary policy transmission, it is time to significantly adjust the federal funds rate. He says:

"The Federal Reserve will continue to rely on data, and the upcoming economic data is as unpredictable as ever. But rather than waiting for a weak labor market condition to prove the reasonableness of taking more than gradual policy steps, I believe the Federal Reserve's responsibility is to prevent such a situation. Otherwise, maintaining such a strict stance, the Federal Reserve's policy will become passively negative."