Risk of recession forecasted with the advent of the new trade agreement between China and the U.S., as per weigh-in from previous Federal Reserve chief.
Investors are taking a breath of relief as the US-China trade tension seems to be easing, but former central banker Bill Dudley issues a stern warning. This de-escalation of tariffs might create issues for the Federal Reserve, leading to a hasty response that could destabilize the economy.
In a telling Op-Ed for Bloomberg, Bill Dudley, a former president of the New York Federal Reserve, sheds light on potential pitfalls for the Fed in this week's tariff truce. If the Fed reacts too late and the economy plunges into a recession, it might need to drastically cut interest rates - up to 300 basis points.
Dudley expresses concern that the temporary tariff reduction might force the Fed to wait and observe the impacts of the trade war before taking action. "Heads, you lose; tails, you lose," Dudley repeated in another interview on Bloomberg TV. "But it's not the Fed's fault. I'd do the same thing in that situation."
Inflation Remains a Concern
While stocks surged on trade optimism, few economists believe that the US-China relationship will improve enough to cancel out the risk of tariff-induced inflation. Even though tariffs are expected to decrease, they remain high enough to boost price growth this year.
Investors should also be aware that the US-China deal doesn't signal the end of the trade war. Instead, the pair has temporarily cut tariffs to a more manageable level to allow for negotiations. Essentially, the pause just prolongs the uncertainty without eliminating it, according to Dudley.
Analysis by Dudley revealed that the average effective tariff rate would likely end up at 17.8 percent, which could hike US price levels and unemployment rates by 1.7 and 0.35 percentage points, respectively - the exact opposite of the Fed's objectives.
In the short run, Dudley expects the Fed to remain patient and closely watch inflation expectations - a premature cut could speed up economic growth but might worsen inflation. "Being patient also carries risks," Dudley wrote, warning of possible layoffs and a subsequent recession. The Fed will know it's too late to act when unemployment rate skyrockets, according to Dudley.
"If the US slips into a recession, I expect rate cuts of 200 to 300 basis points."
Dudley's concerns underscore the intricacies and uncertainties brought about by trade policies, which can make it difficult for the Fed to effectively manage the economy.
What if the Fed reacts too late to the temporary tariff reduction, risking a need for drastic interest rate cuts up to 300 basis points? In such a scenario, Bill Dudley, former president of the New York Federal Reserve, would have the investing community ask: "But what about finance? What about business?" This question looms large as the Fed navigates the complexities and uncertainties of trade policies, straddling the thin line between maintaining a stable economy and avoiding a potential recession.
