With the Bank of Canada and the European Central Bank becoming the first two G7 central banks to go ahead with rate cuts, traders’ eyes are now firmly on the U.S. Federal Reserve. According to economist Mohmad El-Erian, it is only right that the U.S. central bank starts cutting rates sooner rather than later.
What Happened: The Fed should begin to lower interest rates at the July meeting, said El-Erian in an interview with Fox News. But he was not sure whether it would. “We have got a Fed that is so traumatized by the big mistake they made in 2021,” he said, referring to the large COVID-19 stimulus it handed out.
“They only look at the past,” the economist said, adding that the central bank is reactionary and therefore a rate cut may not be announced in July but should be.
Premising his view on evidence of slowing growth, El-Erian said manufacturing activity indices, retail sales, and job openings data were all weak. All these are saying the economy was slowing faster than most people expected, including the Fed, he added.
“Monetary policy acts with a lag. So you are really targeting the economy of tomorrow,” El-Erian said. “But if you do it based on yesterday’s data, you will likely get it wrong,”
The economist said if they had 2021 so wrong when they decided inflation is transitory, much against warnings by economists, they will now be afraid of making a strategic call now. “We have to respect that,” he said.
El-Erian added that there is a 50% chance of a soft landing — inflation comes down with some sacrificing of growth but not much — a 15% chance of new-age technologies such as generative AI leading to hotter growth without a spike in inflation and a 35% chance of a “hard landing.”
See Also: Best Inflation Stocks
Why It’s Important: The extended rally in the market seen this year is premised on hopes of Fed rate cuts. If the Fed chooses to err on the side of caution, small-cap stocks will likely take a big hit as they are relatively more interest-rate sensitive. This will hinder the broadening of the market rally, a prerequisite for a sustainable uptrend.
The CME Fed Watch tool shows the futures market pricing in a merely 18.5% probability of a rate cut at the July meeting, with such odds at the September meeting increasing to 69%
The Federal Open Market Committee, the rate-setting forum of the Fed, is set to meet for two days beginning on Tuesday. Most expect the status quo to be retained.
Photo by International Monetary Fund on Flickr
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