Mohamed El-Erian, the president of Queens’ College, Cambridge and a Bloomberg Opinion columnist, believes that the Federal Reserve’s decision to soften its inflation target indicates a slowing economy. According to El-Erian, this move by the central bank increases the risk of policy error.
El-Erian stated that the economy is slowing faster than expected by economists and the Fed itself. In May, the price index for personal consumption expenditures (PCE) rose 2.6% year-on-year, which is the slowest rate this year. The Fed has been aiming for an inflation rate averaging 2% as measured by the PCE price index with its interest-rate increases over the past two years. However, El-Erian noted that there are few buffers in place as the economy slows down. He suggested that a rate cut in July should be considered by a forward-looking Fed but warned that it is still relying too heavily on historic data to make changes.
Fed officials recently updated their forecasts, with a median projection of one quarter-point rate cut this year instead of three projected in March. Market interest rates are already anticipating at least one quarter-point cut this year possibly as early as September. El-Erian warned that if the Fed keeps rates too high for too long, it risks triggering a US recession with a 35% chance compared to a 50% chance of a soft landing.
In El-Erian’s opinion, if the Fed does not begin cutting rates early enough, it may need larger rate cuts down the line to address the slowing economy. While it seems unlikely that there will be a July rate cut based on current circumstances, El-Erian emphasized the importance of being proactive in adjusting monetary policy to avoid falling into an economic downturn.
Overall, El-Erian’s comments suggest that while inflation may have softened in recent months, it does not mean that economic growth will continue at its current pace or even pick up again soon. Instead, he believes that policymakers must remain vigilant and proactive to prevent an economic downturn caused by prolonged low growth and high levels of debt.