Wharton professor urges Fed to make emergency rate cuts

Wharton School professor Jeremy Siegel is calling on the Fed to slash interest rates before its September meeting—and by quite a bit.

Siegel, who currently serves as chief economist at WisdomTree, told CNBC that the Fed should make an emergency rate cut of 0.75% as soon as possible, followed by another 0.75% cut in September.

“The fed funds rate right now should be somewhere between 3.5% and 4%,” Siegel said, explaining that this is “very simple logic” based on the Fed’s own policy objectives.

“At the June meeting, the Fed said that the long-run fed funds rate when inflation reached 2% and unemployment has come up [to 4.1%] should be 2.8% [...] 2.8% is the normal fed funds rate,” he said.

Last week, the Department of Labor Statistics reported that July’s unemployment rate surged to 4.3%, the highest in nearly three years.

In Siegel’s view, rising jobless numbers signal the central bank's failure to fulfill its dual mandate of stabilizing consumer prices and supporting full employment.

“As far as inflation, we’re at 2.5%. We’ve gone down 90% toward the target on the inflation rate. We’ve overshot the target on the employment. Those are the two targets explicitly mentioned by the Federal Reserve,” he said.

“And how much have we moved the feds funds rate? Zero. That makes absolutely no sense whatsoever.”

The end of the yen carry trade?

The Fed’s inaction following its July 30-31 meeting may have fueled the recent turmoil in global financial markets after the Bank of Japan (BOJ) raised interest rates to 15-year highs.

Before the BOJ hiked interest rates, Japanese interest rates were effectively zero, which allowed investors to borrow excessively in yen, convert the funds into U.S. dollars, and buy assets at basically zero cost.

The so-called “yen carry trade” allowed investors to borrow trillions of dollars worth of yen to invest in higher-yielding assets. But after the BOJ's hikes, the yen rose 7.5% against the dollar, forcing investors to unwind their positions.

“You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” wrote Kit Juckes, chief foreign exchange strategist at Societe Generale.

Juckes said the recent string of negative U.S. economic data added fuel to the fire by sparking a “huge reaction” in a largely illiquid summer market.

According to macroeconomist Alex Kruger, the big policy mistake wasn’t that the Fed didn’t cut rates fast enough but rather that the central bank didn’t cut rates while the BOJ hiked.

“This is hindsight, obviously, and we now need U.S. economic data to confirm this,” he said.