Why the Federal Reserve Should Implement a 0.5% Rate Cut in September!!

The Federal Reserve is set to reduce interest rates this month, with many anticipating a modest cut of 0.25%. However, Michael Feroli, chief economist at JPMorgan, argues for a more substantial 50 basis point (0.5%) cut.

Feroli contends that a smaller reduction will not sufficiently stabilize the economy. Currently, the Fed’s target rate is between 5.25% and 5.50%, which Feroli views as excessively high. He believes the neutral rate—where monetary policy neither stimulates nor slows the economy—should be closer to 4%. This suggests that the Fed is about 150 basis points above the ideal level. As Feroli puts it, “We think there’s a strong case for accelerating the pace of rate cuts.”

According to the CME FedWatch Tool, there’s a 39% chance the Fed will opt for a 50 basis point cut, lowering the target range to 4.75% to 5%. However, most predictions favor a 25 basis point reduction, with a 61% likelihood. Feroli warns, “If you wait until inflation is back to 2%, you’ve probably waited too long.” Inflation is currently slightly above this target, and unemployment is rising.

The job market displayed the weakest private payroll growth in August since early 2021, and the unemployment rate climbed to 4.3% in July. This trend raises concerns, including those highlighted by the Sahm Rule, which signals recession warnings when unemployment increases sharply.

Despite the softening job market, Feroli believes the economy is not on the brink of collapse. However, if the situation were truly dire, there would likely be more discussion about larger rate cuts.

The primary risk of a significant rate cut is the potential for inducing risky behavior in financial markets, which could lead to bubbles in real estate or stocks. Cheap borrowing costs might drive investors into riskier assets, potentially inflating prices and setting the stage for a market crash when these bubbles burst.

The Fed will decide during its meeting on September 17-18. A more substantial cut could provide the necessary boost for economic growth while keeping inflation in check. Conversely, a gradual approach might result in higher unemployment before inflation is fully controlled.