Former Federal Reserve economist Sam: The Fed should cut interest rates by 50 basis points

As they entered Tuesday's policy meeting, Federal Reserve officials moved closer to achieving their goal of low inflation, but how they will adjust interest rates remains an open question. Inflation data shows that after a sharp rise from 2021 to 2022, price pressures have eased significantly. One consumer price index shows that the 12-month inflation rate has reached its lowest level since February 2021, while wholesale price indicators suggest that price increases are largely under control.

These data are apparently enough for the Federal Open Market Committee (FOMC) to make a decision to cut interest rates at the end of this week's meeting and update its forecasts for the central bank's future direction.

Former Federal Reserve economist and chief economist at New Century Advisors, Claudia Sahm, said in an interview last Friday: "Since the last Fed meeting, we have had two more months of good inflation data, which is what the Fed has asked for."

However, the question now is how much action the Fed should take. The financial markets, as a guide to the central bank's direction, have not been helpful in this regard. According to the CME Group's FedWatch tool, futures markets focused on a 25 basis point rate cut for most of last week, but on Friday, traders turned to almost equal possibilities of cutting 25 or 50 basis points.

Sahm is one of those who believe the Fed should take bigger actions. She said: "Based on inflation data alone, we have enough reason to cut 25 basis points next week, and there will be a series of rate cuts after that." She believes that the federal funds rate has exceeded 5% and has been fighting inflation for over a year. She said: "This battle has been won, they need to start cutting rates."

This means cutting 50 basis points from the start to prevent a potential labor market downturn.

She said: "Since July last year, the labor market has become weak, so some recalibration is needed. We have more information now. Fed officials need to make this 50 basis point cut and be prepared for further action."

Sahm said: "If Powell wants to deliver on 'we don't want to weaken further, we don't want to cool further,' they must take real action, because this cooling trend has been established, and unless it is interrupted, we will continue to see wage declines and rising unemployment rates."

Of course, there is also a considerable amount of support for the Fed to only lower by 25 basis points at next week's meeting, reflecting the central bank's need to do more work on inflation and its lack of concern about the labor market or broader economic cooling.

Tom Simons, U.S. economist at Jefferies, said: "This is the key they really need to focus on, that they are normalizing policy rather than trying to provide accommodation for an economy that is truly in trouble, and I think they are doing very well in this regard."

Even according to Simons' forecast - the Fed only making a 25 basis point cut - the bank still has enough room to take further action in the future In fact, the market price expectations indicate that by the end of 2024, interest rates may decrease by 125 basis points, suggesting a sense of urgency to lower the benchmark borrowing costs from the current highest level in over 23 years - currently at 5.25% to 5.50%.

Simons said, "They are lowering interest rates so cautiously because they are concerned about the resurgence of inflation. Now, based on data indicating that inflation will not immediately rise, they have more confidence. However, they do need to carefully monitor potential changes."