El-Erian: Fed Has Lost Credibility; In Lose-Lose Situation

Few people have been more consistent and correct about the threat of inflation and the Fed’s generational failure to tighten monetary policy last year than Mohamed El-Erian, Allianz Chief Economic Advisor, who began warning of inflation overshoots in Spring 2021 and begged the Fed over and over to begin tightening all throughout 2021.

Mr. El-Erian spoke with CNBC last week and summed up the Fed’s current predicament: they’ve lost their credibility, and are faced with the choice of causing a recession to get inflation under control, or letting inflation rip.

“The whole point of forward policy guidance by the Fed is to bring along the markets in an orderly fashion by the Fed. Instead, we’re seeing the market run away further from the Fed and doing so in a disorderly fashion. That is why the risk of a policy mistake is so high. When you lose credibility you start chasing the market but the markets start running away from you even more…”

“I think that if the Fed ends up validating what the Fed is now tempting it to do, the Fed will end up breaking something in the economy, but if the Fed doesn’t validate what the market has done the Fed will not re-establish its inflation credibility. That’s the lose-lose outcome… that I’ve been worrying about since last summer.”

“They (the Fed) need to re-establish (their credibility)… and it starts with them being dead honest about why they made such a big mistake and explaining to people why you are (now) better at forecasting inflation. I don’t think that the marketplace believes that the Fed is better. Breakevens moved against the Fed when Chair Powell was saying that he is very serious about addressing inflation…”

“People speak with confidence about (the neutral policy rate). There’re two problems. One is that neutral has proven to be very variable… and the second is how do you judge neutral taking into account the fact that the economy and the market have been conditioned for years to live with very low interest rates… I don’t know where neutral is…”

“I don’t think the market has factored in yet what’s going to happen to the economy as all these changes start transmitting through the economy… We’re going to see a global stagflation… We’re going to see depression in Russia and Ukraine. We’re going to see recession in Europe. We’re going to see stagflation in the US and we’re going to see a number of commodity importing developing countries running into debt problems…”