On Wednesday, August 7th, Eastern Time, Dudley published a column titled "The Fed's Wild Ride Has Only Just Begun," warning that to avoid a recession, the Federal Reserve might cut interest rates by more than expected at the next meeting in September.

As Wall Street Journal had mentioned, Dudley, who had called for the Federal Reserve to raise interest rates in 2019, made a 180-degree turn two weeks ago, shifting from a staunch hawk to a dove, urging the Federal Reserve to act now, preferably deciding to cut interest rates at the end of July meeting, believing that waiting until September to cut rates would increase the risk of a recession.

He pointed to an unsettling signal of the economic situation: the three-month average unemployment rate rose by 0.43 percentage points from the previous 12-month low, very close to the threshold of 0.5 set by the Sam Rule. If it exceeds 0.5%, it indicates entering a recession.

At that time, Dudley pointed out that Federal Reserve officials misunderstood the labor market and were not very concerned about the risk of the unemployment rate breaking the Sam Rule. They felt that the rise in unemployment was due to rapid labor force growth, not an increase in layoffs. However, this logic is unconvincing. The Sam Rule accurately predicted the recession of the 1970s, when the U.S. labor force was also growing rapidly. Historical experience shows that at this level of cooling in the labor market, it tends to decline more quickly, and delaying interest rate cuts would increase the risk of recession.

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In his column on Wednesday, Dudley said that in the past two weeks, there has been more evidence showing that the U.S. labor market is weakening, and inflation is further easing. He again mentioned the warning signal of unemployment levels, stating that the three-month average unemployment rate has reached 4.13%, 0.53 percentage points higher than the lowest level of the previous 12 months.

This has exceeded the threshold of 0.5% set by the Sam Rule, indicating a recession in the U.S. economy, and future unemployment rates will rise significantly. At the same time, he mentioned the Federal Reserve's favorite inflation indicator - the core PCE price index increased by 0.2% month-on-month in June, and has been growing moderately for three consecutive months.

Recently, many economists, including Sam, the proposer of the Sam Rule and a former Federal Reserve economist, believe that the Sam Rule may not be applicable this time. In other words, what is driving the rise in unemployment this time is not layoffs, but an increase in labor supply. Sam said that the Sam Rule has become somewhat ineffective and cannot prove that the U.S. economy has fallen into a recession.

At the end of July, at the post-Fed press conference, when Fed Chairman Powell was asked about the Sam Rule, he replied that he would like to call the rule a statistical law, not an economic rule that can tell you something might happen.

Dudley wrote in his article on Wednesday that the views of the above economists may be correct, but he would not formulate monetary policy based on this assumption. The Sam Rule reflects a fundamental economic process: that is, the deterioration of the labor market tends to reinforce itself. When the threshold of the Sam Rule is broken, the unemployment rate will always rise significantly. The minimum increase from the trough to the peak is close to 2 percentage points. In that case, what should the Federal Reserve do?

Dudley believes that the longer the Federal Reserve delays interest rate cuts, the greater the potential harm. The neutral interest rate level expected by Federal Reserve policymakers is between 2.4% and 3.8%, which means that the current 5.3% effective federal funds rate is far from the neutral level. Once the U.S. really falls into a recession, the Federal Reserve will need to lower interest rates to 3% or lower.The Federal Reserve could certainly lower interest rates immediately, but the likelihood is slim. Such a move would not align with Powell's prudent approach. The Fed rarely takes emergency action outside of its regularly scheduled decision-making meetings, unless the United States faces a severe shock that significantly alters the economic outlook or threatens financial stability.

From this, Dudley speculates that at the September monetary policy meeting, the Fed may decide to cut rates by 25 or 50 basis points, with the exact magnitude depending on the economic data between now and then.

The path of interest rates after September remains unclear. It could be a series of gradual rate cuts of 25 basis points, eventually bringing the policy rate below 4%, or if the Sum Rule predicts accurately, the Fed would make a substantial rate cut.

Dudley warns at the end of the article that the outlook for the Fed's monetary policy may still be very uncertain in the coming months. Therefore, stock and bond markets will experience more volatility, and everyone should be prepared for significant fluctuations.