Mohamed El-Erian warns the Fed has lost most of its credibility – and markets expect it to cause more ‘collateral damage’

The Federal Reserve has lost most of its credibility, leaving the US at risk of considerable economic pain, according to Mohamed El-Erian.

The economist warned on Wednesday that the Fed’s failure to tame inflation this year meant that markets were no longer confident that a US recession could be avoided as it tightens monetary policy.

“Markets see a central bank that expects to cause more collateral damage as it tries to meet its inflation target,” El-Erian wrote in a Project Syndicate op-ed. “Jerome Powell said as much this month when he continued to distance himself from the possibility of a soft or ‘softish’ landing, as he once put it.”

The Fed announced its third-consecutive 75 basis point interest rate rise last week as it battles to bring soaring inflation under control.

Stocks have tumbled since his speech, with the benchmark SP 500 down 3.8% over the past seven days.

“Powell has now repeatedly signaled more ‘pain’ ahead, implying an uncomfortably high probability of recession,” El-Erian said. “The market appears to agree with this outlook: the yield curve is inverted, with the yield on 10-year Treasury bonds having fallen to around 40 basis points below that on two-year bonds.”

While the Fed is now hiking interest rates aggressively in a bid to tame soaring prices, El-Erian believes it initially lost credibility with markets because it fueled the “everything bubble”of 2021 by keeping interest rates low even as inflation prints started to steadily climb.

“The US needs more monetary-policy tightening than it would have if the Fed had reacted in a timely and credible fashion,” he said. “That will indeed produce ‘pain’ in the form of foregone growth (actual and potential) and higher unemployment, which will hit the most vulnerable segments of society the hardest.”