If the Federal Reserve cuts interest rates urgently, it will make two "huge mistakes"!

The global stock market sell-off on Monday shocked many professional investors, Wall Street leaders, and economists, leading to calls for an emergency rate cut by the Federal Reserve.

However, Mohamed El-Erian, the Dean of Queen's College, Cambridge University, stated, "I strongly oppose the idea of cutting rates between meetings. That would be a huge mistake, it's a bit like going to the emergency room for a cough."

The former CEO of Pacific Investment Management Company (Pimco) said, "There are many other options before you go to the emergency room."

El-Erian believes that implementing an emergency rate cut by the Federal Reserve would pose two main problems.

He said, " First, it would inadvertently weaken expectations—possibly making people more cautious, companies more cautious, and credit providers more cautious," When the Federal Reserve chooses to cut rates in an emergency, it may scare corporate leaders, Wall Street analysts, and others.

This weakening of expectations could even lead to a recession. El-Erian stated on Monday that as people become increasingly concerned about the economy, the Fed's panic could lead to reduced consumption, creating a " self-reinforcing negative cycle".

He currently believes that there is only a 35% chance of a recession in the next 12 months.

In El-Erian's view, the second reason to avoid an emergency rate cut is "moral hazard", meaning that whenever the market falls, Fed officials are eager to save the market by cutting rates.

He said, "As long as the market is functioning normally, the Fed should allow the market to adjust on its own, otherwise, this will foster moral hazard in the market—don't worry, the Fed will always intervene in volatility."

El-Erian explained that some crowded trades are stimulated by sudden changes in economic and policy narratives. He wrote in an article, "This squeeze is further exacerbated by the deleveraging in Japan and the overvaluation of certain areas in the market such as tech stocks."

Emergency rate cuts by the Federal Reserve are usually used for more severe and systemic issues, including major recessions, pandemics, or more severe market declines.

El-Erian believes that in the future, the Fed should be more strategic in its policy guidance, adding forward-looking elements to alleviate concerns about the Fed falling behind the actual situation. While the rate cut in September was important, the magnitude of the cut is not as important as the Fed's communication before the cut.

He said, "Powell must regain authority and make forward-looking policy guidance more meaningful ."

"You know, I've been in this industry for a long time, I have never seen so many changes in the Fed's forward-looking policy guidance. The reason is that they have become too reliant on data, which has ended up amplifying volatility rather than providing strategic anchoring for the economy and the market."

El-Erian believes that Monday's market decline was "far from" the severity of past events that triggered rapid policy changes by the Federal Reserve.

Nevertheless, the possibility of a rate cut between meetings is not zero, especially if the market declines again, considering the historical background of current Fed officials Adrian said, "I think the probability of this happening is 10%, why not lower? Because the Fed has been pressured by the market once before. If you remember, in the fourth quarter of 2018, the market became very turbulent, and the Fed made a big turn in policy, even though the economy didn't need such a turn at that time."