- The Fed would be making a mistake in delivering an emergency rate-cut, Mohamed El-Erian said.
- That policy move could easily "backfire," the top economist wrote in an op-ed for Bloomberg.
The Federal Reserve would be making a mistake if it delivered an emergency rate cut.
That's according to Mohamed El-Erian, a top economist who urged the central bank not to let itself get pushed around by investors who are clamoring for lower interest rates.
In a Bloomberg op-ed on Tuesday, El-Erian pointed to increasing pressure for Fed officials to dial back rates after weak economic data triggered a steep sell-off in stocks. That's because investors are growing more worried about a potential recession after unemployment spiked and hiring came in unexpectedly soft in July, with bets now ramping up for steeper- or sooner-than-expected cuts from the central bank.
Amid Monday's sell-off Bloomberg reported that markets see a 60% chance the Fed could issue a cut ahead of its scheduled policy meeting. That would represent a rare move by the central bank, which has typically only cut rates outside of its policy meetings in times of extreme volatility arising from black swan events like the pandemic and the September 11 attacks.
Giving in to the market's demands to ease monetary policy would constitute another mistake for the Fed, El-Erian said.
"Given what we know today about the economy, every circuit breaker listed above that requires Fed intervention would constitute a policy overreaction that could well backfire in the longer run," El-Erian wrote.
"Rather than allow itself to be bullied by markets, as occurred in the fourth quarter of 2018, the Fed should stand on the sidelines and let the market overreaction (and that's what I believe we're seeing in government bond yields) play out," he said, adding that he believed the Fed should kick off its easing cycle by issuing a single 25 basis-point rate cut.
Other market commentators have noted that investors' reaction to weak economic data seems extreme. The recent jobs report could have been impacted by summer weather, which could mean the economy isn't as weak as it seems, some forecasters note.
"It would represent a huge moral hazard and a bad precedent if the Fed allowed two days of stock price declines in high-flying and highly valued issues to dictate monetary policy," Ben Kirby, the co-head of investments at Thornburg Investment Management, wrote in a note on Tuesday.
"If the selloff continues, and the risk of a de-grossing in some parts of the market appears to be creating a contagion risk that will feed back into the economy, then the Fed may be forced to act. But we think that thesis is far from certain at this time."
El-Erian, a prominent critic of the Fed, has repeatedly warned markets of the dangers of dialing back interest rates too early, as that could fuel a resurgence of inflation. Still, he was among those calling for the Fed to cut rates ahead of its July meeting, pointing to the rising risk of recession as economic activity continues to weaken.