Former Federal Reserve of New York boss William C Dudley warns US could go into recession

An influential ex-member of the Federal Reserve warns the US is unlikely to achieve a soft economic landing, but faces a recession if unemployment rises by as much as forecast.

Influential former Federal Reserve Bank of New York president William C Dudley has warned that the Fed is likely to engineer a recession instead of a soft landing as it attempts to tame inflation by lifting interest rates.

Speaking at the UBS Australasia Conference in Sydney on Monday, Mr Dudley said that history suggested any moderate increase to the unemployment of more than 0.5 per cent in a cycle always results in a recession and will lead to an even greater number of people out of work.

Unemployment in the US has climbed from 3.7 per cent a year ago to 3.9 per cent in October, with the Federal Open Market Committee forecasting that to climb to 4.7 per cent by the end of 2024.

“If the unemployment rate goes up at more than about a half a percentage point, you typically have a full-blown recession, and the next step is an unemployment rate rise at a minimum, across the peak, of two percentage points,” Mr Dudley said.

“Either the unemployment rate goes up trivially, and you have a soft landing, or it goes up a lot.”

William Dudley, former president and chief executive officer of the Federal Reserve Bank of New York. Picture: Bloomberg

An unemployment rate that climbs above 4 per cent in the months ahead is consistent with an increased chance of a recession outcome because it would have increased moderately and would be unlikely to settle around that number, Mr Dudley said.

“Every time it’s gone up by more than a half a per cent from the drop, you actually had a full-blown recession, 12 out of 12 times in the post-World War period in the US,” he said.

“And more importantly than that, when it goes up by more than a half a per cent, it doesn’t stop there. It keeps going.”

Central banks including the Fed and the Reserve Bank in Australia are attempting to engineer a soft landing, where rising interest rates slow economic growth to an acceptable degree relative to inflation and keep the number of people out of work to a minimum.

Both central banks are looking to return inflation to be around 2 per cent annually and Mr Dudley expects that the Fed is unlikely to cut interest rates until it reaches that level to avoid an Arthur Burns situation in the 1970s when he cut rates early, resulting in inflation expectations being unanchored.

Federal Reserve governor Jerome Powell last week reaffirmed the central bank’s commitment to bringing inflation down to its benchmark target of 2 per cent.

Mr Dudley, who also serves as a UBS board member, said that while it was possible to engineer a soft landing and return inflation to a 2 per cent target, he was betting that would not happen because of rising unemployment.

“It’s likely that we need to see a little bit more slack than there currently is in the labour market and if we have more slack in the labour market we hit that historical point where the unemployment rate has gone up by more than half a per cent,” he said.

“I wouldn’t bet against that relationship because that relationship is held every time.”

UBS forecasts that headline inflation in the US will increase by 0.4 per cent in October to be 3.3 per cent over a 12-month period when it is released later this week. Mr Dudley added that it was not known what the required unemployment rate is to return inflation to the Fed’s target of 2 per cent.

The federal funds rate is at 5.25 per cent to 5.5 per cent.

Federal Reserve Board Chairman Jerome Powell last week reaffirmed the bank’s plan to return inflation to its 2 per cent target. Picture: AFP

Mr Dudley, who served as president and chief executive of the Federal Reserve of New York between 2009 and 2018, also told the conference that the US government is not “very functional” at the moment and that it is heading down an unsustainable path as the world’s largest economy faces a fiscal imbalance.

Government debt in the US has been rapidly climbing, with it sitting at $US33.07 trillion after the debt ceiling was suspended earlier this year.

“We do not have a very functional government in the United States right now in terms of getting things done,” Mr Dudley told delegates.

“Democrats and Republicans have totally different views about how they would actually go about and address a fiscal imbalance.”

Fiscal imbalance is where the revenue-raising abilities of the governments do not coincide with their spending responsibilities.

Mr Dudley added while the fiscal imbalance is not a big driver now, the US is “absolutely on an unsustainable trajectory”.

“There’s very little chance that anyone’s going to do anything about it in a pre-emptive way,” he said.