Dudley believes that the US economic growth will gradually slow down, and the interest rate level will remain high for a longer time. The neutral interest rate level may rise to 3.6%, and the key indicators to be monitored in the future are the unemployment rate and core service inflation.
The prospect for the Fed interest rate cut is still uncertain in the year which has already passed halfway.
On June 28th, Bank of America Merrill Lynch released research reports that sorted out remarks made by the former president and CEO of the New York Federal Reserve Bank, Dudley, at the Boao Forum for Asia in 2024. At the meeting, Dudley analyzed key economic indicators such as the expected economic growth rate, unemployment rate, and service industry inflation, and discussed the prospect of the Fed interest rate cut.
Overall, Dudley believes that the US economic growth will gradually slow down, the Fed will cut interest rates, but the timing and speed of the interest rate cut will be later than the market expected. It is expected that the 10-year US Treasury bond yield will be at 4.5%. The interest rates will remain high for a longer period of time, and the neutral interest rate level may rise.
Interest rates will remain high for a longer period of time, and the neutral interest rate level may rise.
Dudley believes that the US economy is showing a mixed trend overall.
He said at the meeting that the reason for the weaker-than-expected first-quarter GDP was mainly due to the drag of exports and seasonal factors. It is expected that the second-quarter GDP growth rate will rebound to a range of 2%-3%, and salaries are showing strong growth momentum. However, on the other hand, weak retail sales data and household employment surveys bring hidden worries to economic growth.
Secondly, the reason why inflation is stubborn is because economic performance is stronger than expected. The key to unblocking the last mile of anti-inflation lies in the service industry, which is characterized by high prices driven by labor shortages and wages.
Therefore, Dudley pointed out that when economic growth is weak and inflation declines to its target, the Fed will begin to cut interest rates, but currently neither has happened, which means that current monetary policy is actually not that tight. Therefore, he is more inclined to the camp of “higher and longer” interest rates.
Dudley supports the market's expectation that the neutral interest rate level for the Fed's interest rate is 3.6% in 2026-2027, which is higher than the Fed's own expectation of 2.8%. There are two specific reasons:
1) In the coming years, the inflation rate will not decline to 2%, and the 2% inflation target is actually "asymmetric" because the Fed is more inclined to avoid deflation rather than benign inflation;
2) The neutral interest rate level will rise because of the long-term huge fiscal deficit of the United States and the retirement of the baby boom generation, which will curb savings and further push up the neutral interest rate level.
Pay attention to two indicators: unemployment rate and core service industry inflation excluding housing.
Looking to the future, Dudley believes that we need to focus on two indicators: unemployment rate and core service industry inflation excluding housing.
Historically, whenever the unemployment rate rises more than 0.5 percentage points based on the three-month moving average, the US economy always enters a recession.
The main driver of service industry inflation comes from wages. Powell hinted that a 3%-3.5% wage inflation rate may be consistent with a 2% inflation rate, and the current wage inflation rate is slightly higher than 4%.
In addition, Dudley mentioned several risk factors, including elections, fiscal trajectory and financial stability.
Specifically, Dudley believes that Trump's taking office is more likely to trigger the risk of inflation due to his relatively high degree of policy uncertainty during his tenure, and may interfere with the Fed's independence in formulating monetary policy.
On the fiscal side, Dudley believes that the Congressional Budget Office's estimate of a $22.1 billion cumulative deficit for the next 10 years is still too optimistic, although this number has worsened by 10% in the past four months, which may put pressure on interest rate cut expectations, in addition to this, Dudley believes that other financial risks are not significant.
Editor/Jeffrey