The Fed's rapid rate hikes are necessary to stem inflation, but they're pushing risks to financial stability dramatically higher, Mohamed El-Erian says

• The Fed's rapid rate-hiking pace is significantly increasing risks to financial stability, economist Mohamed El-Erian warned.
• In a Bloomberg column, he pointed to risks in bond markets and said non-banks that are less regulated have become the weakest links.

The Federal Reserve's late policy response has necessitated a rapid pace of rate hikes, but that has dramatically heightened risks to financial stability, according to Mohamed El-Erian.

In a Monday Bloomberg column, the chief economic adviser at Allianz pointed to risks in G7 bond markets and said non-banks that are less regulated have become the weakest links in leverage- and derivative-heavy markets.

He said the Fed fell behind its price-stability mandate and wrongly pegged inflation as transitory last year. As a result, El-Erian said, the Fed faces a delicate balancing act between taming soaring prices without sparking a recession.

What's more, El-Erian noted that policymakers have been basing decisions on lagging economic data, all while the global financial landscape — from the UK to China — sees more turmoil.

Fed Chair Jerome Powell has been tasked with reversing the easy-money era of the past decade, when markets enjoyed near-zero interest rate levels and high liquidity. If the Fed is not both careful and lucky, El-Erian said, shifting away from that framework could lead to a recession as well as broad de-leveraging across the financial system and real economy.

"The faster the rate-increase cycle, the greater the risk of large financial accidents with nasty economic spillovers," he said, adding that the central bank has already developed a shaky reputation for stemming inflation.

"The Fed is increasingly stuck in a three-dimensional rock-versus-hard-place situation."