The Fed is 'held hostage' by data and risks sparking financial instability, Mohamed El-Erian says
- The Fed's over-dependence on data risks financial instability, Mohamed El-Erian wrote in a recent op-ed for Bloomberg.
- He says the central bank became too focused on inputs after misreading inflation in 2021.
The Federal Reserve's strict adherence to data is sapping it of policy alternatives, economist Mohamed El-Erian wrote for Bloomberg on Friday.
If the central bank concentrates too heavily on data points, it risks keeping interest rates up for a longer than necessary, which could lead to higher unemployment, instability and output loss, he outlined.
"There is an important distinction between being informed by the numbers and being held hostage by them — particularly for an institution whose tools operate on the economy with a lag," El-Erian said.
So far into 2024, the fed funds rate has remained paused at a range of 5.25%-5.50%. Hopes that the central bank would cut rates in the first half of the year have diminished, as both inflation and GDP metrics have come in hotter than anticipated.
Even as the latest personal consumption expenditures index matched expectations, recent Fed commentators have agreed that there's no rush to ease monetary policy. Many central bank officials want to see a clear disinflationary trend in the data before cutting rates.
To El-Erian, this data-driven approach stems from the Fed's misreading of inflation during the pandemic; in 2021, the central bank was late in raising rates, having argued that inflation was transitory and would pass.
But now, wth its emphasis on economic inputs, it may have overcorrected:
"Indeed, this dependency has become deterministic in the Fed's decision making and communications, and has contributed to uneven signaling, reactive measures, sudden pivots and unnecessary market volatility," El-Erian wrote.
And more data shifts are laid ahead of the Fed, as the final stretch to its 2% target inflation rate tends to be the hardest to overcome. A "tug of war" between goods deflation and high services inflation will likely continue to reposition future data.
"Historic data should not be the sole determinant of policy making. This ongoing obsession with the numbers should give way to an approach that also incorporates strategic vision and forward-looking insights on where the economy is heading," El-Erian wrote.
The economist previously warned that the Fed would risk a recession if it cut rates later than June, the month in which most investors expect policy to pivot.
But still others, such as Apollo's Torsten Slok, see things differently. He expects the Fed to keep rates unchanged through 2024, citing that neither inflation nor the US economy is sufficiently cooling.