Fed’s dovish pivot is big gamble that’s likely to fail, says former top New York Fed official

Former New York Fed President Bill Dudley is wading into the current debate on the U.S. central bank’s dovish pivot last week, and warning of a chance that things could go wrong.

In a Bloomberg column on Monday, Dudley wrote that Fed Chair Jerome Powell and other policy makers are taking a pretty big gamble by expecting that they’ll be able to vanquish inflation without causing a U.S. recession. At the moment, the Fed’s thinking amounts to the idea that further drops in inflation should make earlier and more rapid rate cuts possible, and officials have penciled in three quarter-point cuts for next year.

But a pivot like the one being contemplated by the Fed would also reduce the risk of either an economic downturn or even harder landing, through its spillover effects into financial markets, according to Dudley. The more weight that Powell puts on cutting rates to avoid a recession, “the greater the risk of failing to control inflation — and of markets getting a big, unpleasant surprise,” Dudley wrote.

The problem is that the central bank’s dovishness “increases the possibility of no landing at all — that is, overheating and persistent inflation that could undermine the Fed’s credibility, while requiring renewed tightening and a deeper recession to get things back under control,” according to the ex-New York Fed president.

And “there’s plenty that can go wrong,” Dudley said. One is that the slowdown in the economy seen late this year might reverse in 2024. Another is that prices could accelerate again, with services inflation excluding housing possibly proving to be more unexpectedly stubborn. And a third is that the job market could remain too tight if 2023’s large increase in labor supply fails to extend into the new year.

On Monday, traders in the U.S. government-debt market were evaluating the case against an early 2024 pivot by the Fed, with a selloff in Treasurys pushing 10-
BX:TMUBMUSD10Y
and 30-year yields
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slightly higher for the day. Meanwhile, all three major stock indexes
DJIA

SPX

COMP
finished higher, with the Dow Jones Industrial Average ending at another record close of almost 37,306.

Fed funds rates traders were still mostly expecting five to seven quarter-point rate cuts by next December, according to the CME FedWatch Tool. The fed funds rate target currently sits at a 22-year high between 5.25%-5.5%

See: Fed could be the Grinch who ‘stole’ cash earning 5%. What a Powell pivot means for investors.