Allianz Chief El-Erian: The Federal Reserve should focus on these two things rather than cutting interest rates

As the interest rate decision meeting on November 7 approaches, Allianz Chief Economic Advisor El-Erian recently stated that the Federal Reserve needs to learn lessons. Instead of focusing on interest rate cuts, the Fed should pay attention to two things: first, maintaining policy stability, and second, abandoning the "only game in town" mentality.

On November 4, El-Erian mentioned in a newly published article that, firstly, the Fed should adopt a more stable policy direction, preferably signaling in the next few meetings and lowering rates at a steady pace of 25 basis points.

Secondly, the Fed should recognize that after dominating the policy center stage for many years ("only game in town"), it is time to make room for other policymakers, as the outlook for the U.S. economy will increasingly depend on the impact of policy changes in other countries after the elections.

El-Erian stated that over the past few decades, policymakers have been overly confident in using demand management policies to "fine-tune" the economy, but historical lessons show that maintaining a stable policy direction is more important than reacting to every data point, except in extreme situations like high inflation and economic recession. He emphasized:

"The Fed should learn this lesson, even if this realization comes a bit late."

El-Erian suggested that policymakers should replace the overconfidence in "fine-tuning" high-frequency data with a stance of stability and sustainability.

He pointed out that the Fed made a policy mistake in 2021 by incorrectly describing inflation as "transitory" and seems to have forgotten this lesson . The Fed's reliance on data led to an overreaction to noisy historical data, lacking the more strategic forward-looking approach required for using policy tools with "long and variable" lags.

El-Erian indicated that the resulting policy volatility over the past 12 months has led to sharp fluctuations in market expectations for policy rates and related bond yields, which serve as benchmarks for many financial instruments, such as:

The Fed believed there was no need to cut rates at the end of July, but at the next policy meeting in mid-September, the Fed unexpectedly cut rates by a significant 50 basis points, lowering the federal funds rate from a range of 5.25% to 5.50% to a range of 4.75% to 5%.

The so-called "quiet period" before the Fed's policy meeting unusually communicated a "large rate cut" through newspaper "leaks" rather than confirming the market's then-expected 25 basis points.

Furthermore, more confusingly, the effect of this rate cut was offset by a subsequent rise of over 70 basis points in the 10-year U.S. Treasury yield, a process that seemed to shake several Fed officials' confidence in their decision.

Moreover, the market's reaction is just one of many extreme fluctuations. Currently, the market's expectation for the Fed to cut rates significantly by 50 basis points again plummeted from 60% to 0% in the two weeks leading up to October 4, and the assessment of the final rate in this rate-cutting cycle has also changed dramatically, with expectations for it to drop below 3.25% by June 2025 falling from nearly 80% to 0