Jeremy Siegel, a professor at the Wharton School, known as the "Godfather of Stocks," recently wrote that the Federal Reserve should consider a more substantial rate cut, or else face the risk of an economic recession. Here are his views.

All debates about the upcoming Federal Reserve meeting are focused on whether Powell will cut rates by 25 or 50 basis points. However, most economic models suggest he should choose the federal funds rate level that best fits the economic conditions, rather than focusing on the speed of cutting rates from a very restrictive level.

Choosing between a 25 and 50 basis point cut is like a driver going 60 miles per hour on a winding mountain road where the speed limit is 25 miles per hour. Common sense tells us that he should slow down immediately rather than gradually decelerate to 55 miles per hour under worsening road conditions.

When setting the federal funds rate, the Federal Reserve follows its dual mandate of maintaining stable inflation and full employment. According to the Fed, the labor market is now balanced, with an unemployment rate at the long-term target of 4.2%, and other labor market indicators also back to normal ranges. Although inflation is slightly above the Fed's target on a year-on-year basis, it is very close to its target - with oil and commodity prices dropping rapidly, the 2% inflation goal can be quickly achieved. In these two aspects, the Fed has basically reached its targets.

At the June meeting, the Federal Reserve stated that when achieving its dual mandate, the federal funds rate should be at 2.8%, what the Fed and economists call the neutral rate level. However, there is a significant uncertainty around this rate: estimates of the neutral rate from the 19 Federal Open Market Committee (FOMC) members range from a low of 2.4% to a high of 3.8%.

I believe the neutral rate is closer to the highest estimate (3.8%), but the current rate of 5.3% is still about 1.5 percentage points higher than this highest estimate. Almost all Fed policy rules, including the Taylor Rule, indicate that the current rate should be 4% or lower. If the Fed believes in the median estimate from its economists and FOMC members in the June economic forecast survey, then the Fed policy rate should already be in the range of 3% to 4%.

Furthermore, Powell often reiterates a well-known fact that monetary policy has "long and variable lags," a statement popularized by the late Nobel laureate and monetary economist, Friedman. If this is true, then maintaining the current or near-current policy rate levels will greatly increase the likelihood of an economic slowdown or recession.

Some people claim that the Fed should maintain the current level of interest rates because the economy is running smoothly with a growth rate of 2% and there are almost no signs of a recession. However, the bond market expects interest rates to be significantly cut in the next 12 months, with the yield on 10-year US Treasury bonds being 150 basis points lower than the current policy rate.

If interest rates follow the gradual decline path set by the Fed in the June dot plot, then the bond traders' judgment is incorrect and the yield on 10-year US Treasury bonds will rise significantly. This will greatly weaken the US stock, bond, and real estate markets and dramatically increase the possibility of an economic recession.

Powell, like our driver speeding on a mountain road, may indeed safely reach the destination and declare his policies a success. But if the road becomes increasingly steep, he - and the US economy - may find themselves heading for a cliff.

Editor/Lambor