After two market-shaking reports last week, another senior central bank journalist has spoken out: interest rates should be cut by 50 basis points!

As inflation gradually cools and the labor market rapidly cools down, the Fed's interest rate decision this week is more complex than ever.

Currently, the market's predictions for the extent of the Fed's rate cut are still divided. Last week, Nick Timiraos of "New Fed News" published an article suggesting that a rate cut of 25 basis points or 50 basis points is a "close call." Matt Luzzetti of Deutsche Bank believes that the article tends to support a larger rate cut.

Colby Smith of the Financial Times also published a similar article, with Matt Luzzetti interpreting that the article tends to oppose a larger rate cut.

On the 15th, Greg Ip, a senior central bank reporter for the Wall Street Journal, analyzed the current economic situation and believed that the need for further Fed rate cuts is increasingly apparent, calling for a 50 basis point rate cut. CNBC reporter Carl Quintanilla commented, "Opinion leaders have spoken!"

Inflation is close to the Fed's 2% target

Greg Ip believes that the current economic environment has undergone significant changes, with "inflation victory now a certainty," providing ample reasons to support a significant Fed rate cut.

According to the latest data, some core inflation indicators have fallen below 3%, even approaching the Fed's 2% target. For example, the core inflation rate excluding food and energy price fluctuations has dropped from 4.2% in August last year to 2.7%.

An equivalent basic inflation rate calculated by Harvard University economist Jason Furman also shows that the current basic inflation level is approaching 2.2%, the lowest since early 2021.

Therefore, the continuous decline in inflation levels provides the Fed with a more accommodative environment for rate cuts.

In addition, Greg Ip believes that changes in oil prices are also an important factor affecting inflation. Oil prices reached $83 per barrel in July, but have recently fallen below $70. The decline in oil prices not only directly reduces the overall inflation rate but also indirectly suppresses the core inflation rate, as oil as a key production input affects costs across industries.

According to a study by the University of California, Los Angeles, oil price fluctuations can explain 16% of core inflation changes, and their impact gradually manifests over two years.

Interest rates may need to return to neutral

Not only has current inflation slowed down, but market expectations for future inflation have also further declined. Data from inflation-linked bonds and derivatives show that CPI is expected to rise by only 1.8% in the next 12 months, with an average inflation expectation of 2.2% over the next five years. This indicates that investors are confident in the Fed's ability to achieve the 2% inflation target.

However, the decline in these inflation expectations also means that real interest rates are rising. Current real short-term interest rates have reached 3.2% to 3.5%, while the Fed's "neutral" real interest rate range is only 0.5% to 1.5% Greg Ip believes that this indicates that the current level of interest rates is significantly more suppressive to economic activity than necessary. Therefore, the Federal Reserve has even more reason to cut rates significantly.

In 2022, the Federal Reserve raised rates by half a basis point and three-quarters of a basis point because the real interest rate at that time was negative, far below the neutral level. Now, in the context of easing inflation, applying the same logic should work in reverse.

Cooling Labor Market

In addition, Greg Ip points out that there are signs of cooling in the current labor market.

Data shows that in July of this year, the U.S. unemployment rate rose to 4.3%, which caused market panic as historically, a similar increase in the unemployment rate often signals an economic recession. By August, the unemployment rate slightly fell to 4.2%. Other economic indicators such as consumer spending, unemployment insurance claims, etc., all indicate that the economy still remains resilient.

Furthermore, the number of job vacancies per unemployed person has decreased from twice the level at the beginning of 2022 to the current 1.1 times, below pre-pandemic levels. Over the past three months, the average monthly job additions in the private sector have been 96,000, also below pre-pandemic levels. This suggests that with fewer job opportunities, the pace of wage growth is likely to slow down, and the threat of inflation remains minimal.

The Fed's Dilemma: Which Risk is Greater?

The Federal Reserve faces a dilemma in every interest rate decision: cutting rates too early may lead to an overheated economy, while maintaining high rates may exacerbate economic weakness. The question is, which choice poses a greater risk?

Greg Ip believes: cutting rates by 50 basis points is not without risks.

Currently, long-term government bond yields are already lower than short-term rates, forming the so-called "yield curve inversion," and may further decline, thereby lowering mortgage rates. Stocks may become a bubble. This will stimulate consumption.

However, if rates are only cut by 25 basis points, the risk may be greater.

The weakness in the global economy is already evident, and auto loan and credit card default rates are rising, high rates are putting pressure on consumers. In fact, many analysts believe that the Fed should have started cutting rates in July. If this time only 25 basis points are cut, and more weak data emerges in the future, the Fed will fall even further behind market expectations