Why the Federal Reserve’s September rate cut should be by 0.5%

The Federal Reserve is finally cutting interest rates this month, and while many are expecting a modest rate cut of 0.25%, Michael Feroli, chief economist at JPMorgan, says the Fed needs to go bigger. He’s calling for a 50 basis point (0.5%) cut.

His reasoning is that a smaller cut won’t be enough to keep things stable. Right now, the Fed’s target rate is between 5.25% and 5.50%, and Feroli thinks that’s too high.

He believes the neutral rate—where the Fed isn’t stimulating or slowing the economy—should be closer to 4%. That means the Fed is currently about 150 basis points above where it should be. Feroli said:

“We think there’s a good case for hurrying up in their pace of rate cuts.”

According to the CME FedWatch Tool, traders see a 39% chance the Fed will opt for the larger 50 basis point cut, bringing the target range down from 4.75% to 5%. But most are expecting a 25 basis point cut, with odds around 61%.

“If you wait until inflation is already back to 2%, you’ve probably waited too long,” Feroli said. Inflation right now is just a little above that target, but unemployment is creeping up.

The job market showed the weakest private payroll growth in August since early 2021, and the unemployment rate rose to 4.3% in July. That’s setting off alarms, including the Sahm Rule, which triggers recession warnings when unemployment rises sharply.

Even with the softening job market, Feroli doesn’t think the economy is collapsing. But he points out that if things were really falling apart, you’d hear more serious talk about cutting rates by more than 50 basis points.

Of course, there’s a big risk here. Cutting rates too much could spark risky behavior in financial markets, leading to bubbles in areas like real estate or stocks.

When money is cheap to borrow, investors tend to pile into riskier assets. If prices in those markets get inflated, it sets the stage for a crash when those bubbles inevitably burst.

The Fed will make its call during its meeting on September 17-18. A bigger cut could give the economy the nudge it needs to keep growing without letting inflation get out of control.

At the same time, cutting rates too slowly might mean that by the time inflation is back in check, unemployment will have climbed too high.

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