The Fed needs to show it will stay tough on inflation after 2 disastrous years where it has lifted then crushed stocks, Mohamed El-Erian says
- The Federal Reserve has lost much credibility after two disastrous years where it failed to act in time on inflation, Mohamed El-Erian said.
- Markets don't believe that interest rates will remain above 5% for long, he warned.
The Federal Reserve will struggle to convince investors that it's committed to taming inflation after two disastrous years in a row that have chipped away at its credibility, Mohamed El-Erian has said.
Allianz's chief economic adviser warned the Fed faces a steep uphill battle to rebuild its inflation-fighting credentials – which it can only win by pressing ahead with the aggressive tightening campaign that's crushed stocks this year.
"To confront such challenges, the Fed will need to move on from the failures of 2021 to 2022," he wrote in a Project Syndicate opinion piece published Monday.
The US central bank kept interest rates close to zero throughout 2021 even as inflation accelerated, helping fuel bubbles in asset classes including stocks, housing and cryptocurrencies.
But since March, it has hiked interest rates to between 4.25% and 4.5% as it tries to contain consumer price pressures. That's hammered stocks and other risk assets in 2022, with the benchmark S&P 500 falling 20% and high-profile growth stock Tesla shedding $600 billion in market value.
At their most recent meeting last week, Fed policymakers signaled that they expect interest rates to rise to 5.1% by the end of 2023.
But futures markets are forecasting the Fed's policy rate between 4.25% and 4.75% in December 2023, according to CME Group's FedWatch tool – signaling that investors think the central bank would ease up on its tightening campaign by then in a bid to steer the US economy out of a widely anticipated recession.
There's now a disconnect between the Fed and markets because the central bank delayed acknowledging that high US inflation wasn't going to be transitory, El-Erian said.
"Policymakers squandered the opportunity to move in a timely fashion to contain the price increases that have since eroded everyone's purchasing power, hitting the most vulnerable segments of society the hardest," the top economist wrote.
"Even after it recognized its mistake, in November 2021, the Fed erred again by not reacting quickly enough," he added.
"Not until March 2022 did it stop injecting liquidity into an increasingly inflationary economy; and its first rate hike that month was a timid 25 basis points."
This isn't the first time that El-Erian has criticized the Fed.
He's repeatedly warned markets to brace for a period of stagflation – a combination of high inflation and sluggish growth – and said in June that prices wouldn't have soared so high if the central bank had raised rates sooner.