Allianz's El-Erian: The Fed should not delay its "first cut" beyond September, otherwise it will repeat policy mistakes

According to the financial news outlet Zhitong Finance, Mohamed A. El-Erian, Chief Economic Advisor of Allianz, stated that two years ago, the inflation rate in the United States soared to over 9%, but has now dropped to around 3%. Following this trend, most economists believe that interest rates should be set at 2.5%-3%, a range that promotes financial stability and solidly anchors inflation expectations. The economist mentioned that if the Federal Reserve fails to cut interest rates in July or September, it would constitute another policy mistake in 2021 after clumsily responding to the rising price pressures and seeking to restore credibility.

El-Erian pointed out that under normal circumstances, this positive news would have prompted the Federal Reserve to consider cutting rates at the upcoming meeting next week, as there are signs that the U.S. economy is slowing down faster than many had expected. However, the current mindset of the Federal Reserve suggests that at the FOMC meeting on September 17-18, it is more likely to only hint at the intention to cut rates.

If the Federal Reserve fails to ease policy in July or September - unfortunately, this outcome cannot be ruled out - it would constitute another policy mistake in 2021 after the initial clumsy response to the continuously rising price pressures and seeking to restore its credibility. One of the reasons for the Federal Reserve's hesitation in cutting rates is its lack of confidence that inflation will continue to decline to the 2% target. Maintaining monetary policy at a restrictive level could increase the likelihood of achieving this target, but it could also cause undue harm to U.S. employment and the economy.

El-Erian explained that in fact, it is far from clear whether 2% is the right target. In a world where there has been a series of favorable developments in terms of insufficient total demand and supply, it was considered an appropriate target, but it may not be so suitable in the fragmented global world; in this world, supply chains are being rewired, and we can observe that domestic supply in the United States has not been so flexible.

Nevertheless, El-Erian believes that after such a long period of forecasting errors and inflation data well above the target, Federal Reserve policymakers are highly unlikely to change the numerical inflation target. A more likely approach for the Federal Reserve is to gradually reduce inflation from now on, clearly stating that its policy is currently highly sensitive to developments in the labor market.

The pressure and stress felt by low-income families and small businesses in the United States have exacerbated the risks of causing undue harm to the economy. Both groups have depleted the cash reserves accumulated during the pandemic, and their debt burdens have become heavier due to high interest rates. They cannot afford the impact of the Federal Reserve's overly restrictive policies - especially when the lagging effects of rate hikes have not been fully absorbed by the economy and the entire financial system.

In recent comments, the Federal Reserve has finally begun to emphasize more the risks facing the labor market, now considering it a more balanced situation. El-Erian stated that further shifts by Federal Reserve policymakers to reflect greater concerns about excessive weakness in employment and economic activity are only a matter of time. The reason why this situation did not occur sooner - similar to the hesitation about cutting rates next week - is because policymakers made a major mistake in 2021: rushing to view the rise in inflation as "temporary" and then becoming overly reliant on data El-Erian pointed out that while waiting for a rate cut in September is not a major issue in macro terms, further delaying the rate cut will cause greater concerns. For an institution that lacks both confidence and sufficient strategic foundation, such procrastination can easily occur. In fact, all it takes is a negative data surprise in the inevitably noisy high-frequency numbers.

So, can the Federal Reserve avoid a hard landing? El-Erian gives the answer: If the Federal Reserve is not constrained by outdated inflation targets, inappropriate monetary policy frameworks, and a mindset overly reliant on data, then the possibility of achieving a soft landing for the U.S. economy and maintaining American economic exceptionalism will be greatly increased. On the contrary, in my assessment, this possibility is only 50% - which is not a reassuring level, especially considering high debt levels, increasing inequality, and a series of non-economic uncertainties faced by the U.S. and global economies