Interview, Podcast
Will Fed policy trigger a US recession?
- Claudia Sahm anticipates a U.S. recession is possible within the next year or so, estimating the risk of an unforced policy error if the Federal Reserve causes it through restrictive actions.
- While the base case is currently not a recession despite the triggering of the Sahm Rule, the probability of a downturn over the next 12 months is assessed at 50 to 60% by Bill Dudley, representing the highest odds seen throughout the current cycle.
- Bill Dudley projects that if a tipping point is crossed following a 0.5 percentage point rise in unemployment, historical trends suggest a further increase of 1.9 percentage points, though a worst-case scenario is likely to be a very mild recession supported by strong household and business balance sheets.
- The speakers warn that supply shocks could drive unemployment past the 0.5 percentage point threshold, potentially overstating the degree of demand weakness, while rising unemployment rates historically trigger downward revisions to initial GDP and employment data.
- Economic turning points are predicted to involve downward adjustments to initial data assumptions, creating uncertainty about whether the economy has truly leveled out, with Sahm expressing caution until the trend stabilizes or the federal funds rate is notably lower.
- Bill Dudley and Rob Kaplan both characterize the Federal Reserve as currently behind the curve in reducing interest rates, with Dudley expecting a rapid shift from a tight to a neutral monetary policy regime to improve the probability of a soft landing.
- Rob Kaplan forecasts the Federal Reserve will begin cutting the federal funds rate in September, with potential reductions in November and December, while maintaining flexibility to cut more than 25 basis points if the August employment report proves weak.
- There is a concern that a strong August employment report could create a false sense of confidence and slow the Fed's response, whereas Sahm notes the institution's conservative nature may lead to waiting longer on rate cuts despite historical lags in monetary policy effectiveness.
- Investors are advised that economic data is backward-looking and subject to revision, urging a focus shift toward structural factors while recognizing the July jobs report as a potential aberration compared to a normal August report.