Central Bank’s Cautionary Approach to Rate Cuts Leaves US Economy Uncertain

According to Mohamed El-Erian, the slowing economy and softening inflation measured by the Federal Reserve’s preferred index suggest that there is an increasing risk of a policy error by the central bank. El-Erian, who is the president of Queens’ College, Cambridge and a Bloomberg Opinion columnist, noted that the economy is slowing faster than predicted by most economists and the Fed. The PCE price index, which measures personal consumption expenditures, rose by 2.6% year-on-year in May, marking the slowest rate this year and meeting expectations.

El-Erian emphasized that the economy is slowing down with limited buffers in place. He suggested that a July rate cut should be considered by a forward-looking Fed. However, he pointed out that the Fed is still heavily reliant on historical data and may not act quickly enough to address current economic conditions. Despite updated forecasts indicating a potential rate cut later this year, market interest rates anticipate at least one quarter-point cut, potentially in September. The likelihood of a July rate cut remains low.

El-Erian warned that there is a risk of the Fed keeping rates too high for too long, which could lead to a more severe rate cut down the line. He believes that the chance of a US recession is currently at 35%, compared to a 50% chance of a soft landing. Ultimately, he believes that the Fed may delay rate cuts and end up having to implement more dramatic cuts than necessary in the future.