Why the Fed's rate-cutting agenda could spark a recession, according to top economist Mohamed El Erian

• The Fed should be more worried about sparking a recession than rampant inflation, Mohamed El-Erian said.
• The top economist estimated there was a 35% chance the US economy could enter an economic downturn.

The Federal Reserve's path of rate cuts could be what ends up causing a US recession, according to top economist Mohamed El-Erian.

El-Erian, who has been flagging the risk of a US recession for the past several years, cast another warning about the state of the economy after central bankers opted to keep interest rates level at their last policy meeting.

Fed officials said they needed more confidence that inflation was on track to fall back to its 2% target before loosening monetary policy.

Officials also dialed back their projection for rate cuts by the end of the year, with median central bank estimates calling for just one 25 basis-point cut in 2024, according to projections released by the Fed.

Central bankers suggested that their most likely move would be to issue one rate cut in December, El-Erian said in an interview with Yahoo Finance on Thursday, but a rate cut by the end of the year would be "too late," he warned, given that the economy already faces an elevated risk of recession.

"In my opinion, 'too late' is what was reflected in yesterday's SEP or dot plot," El-Erian said, referring to the Fed's Summary of Economic Projections. "By that time, the lagged effects of what was a significant increase in rates would be biting even more."

US consumers are already grappling with the higher cost of living. The pile of excess cash that's cushioned small businesses and lower-income households has likely already been spent, with pandemic savings estimated to have run out in March, according to the San Francisco Fed.

Household debt levels have also climbed to an all-time high of $17.6 trillion, while a growing number of auto and credit card loans have transitioned into late-payment status, according to New York Fed data.

"I worry that if they carry through on what is in the SEP, that will be too late," El-Erian added, though he noted that the Fed may choose to further loosen monetary policy when factoring in soft May inflation data. Consumer and producers prices rose less than expected last month.

Though the Fed has signaled just one cut, investors still see two to three cuts by year-end, according to the CME FedWatch tool.

Meanwhile, Fed Chair Powell appeared to acknowledge the risks of keeping rates too high for too long. Elevated interest rates could cut into economic activity and employment, Powell said at a press conference on Wednesday.

At this point, the economy faces a bigger risk of recession than rampant inflation, El-Erian suggested.

"I think what he misses is the balance of that risk. That the balance, unfortunately, is in favor of them being too late and the economy slowing more than it should, and small businesses and low-income households being hit particularly hard," he added, pegging 35% chance the economy could enter a slowdown.

The recession outlook remains mixed, given the cocktail of tight financial conditions and resilient economic growth so far. According to New York Fed economists, the US has a 52% chance of slipping into recession by May next year.