Allianz chief economist Mohamed El-Erian said the weakening of the Federal Reserve's preferred inflation measure highlights the economic slowdown, which increases the risk of a policy mistake by the central bank.
“The economy is slowing down faster than most economists expected and faster than the Federal Reserve expected,” the president of Queens College at the University of Cambridge told Bloomberg TV on Friday.
The US personal consumption expenditure price index (PCE) rose 2.6% year-on-year in May, the lowest level so far this year, in line with expectations. The Fed's goal of raising interest rates over the past two years is to achieve an average inflation rate of 2% measured by PCE.
"The economy is slowing and with little cushion left, if the Fed was forward-looking it would certainly consider cutting rates in July," El-Erian said.
But the opposite is true, the Fed "remains overly data-dependent, claiming it needs a lot of data to change its policy."
The Fed's dot plot released this month showed officials' median forecast was for just one 25 basis point rate cut this year, compared with three in March.
Interest rate markets continue to price in at least a 25 basis point rate cut from the Federal Reserve this year, as early as September, with a July cut unlikely.
Bets that the Federal Reserve will cut interest rates in September and again in December increased after Friday’s PCE data. Traders of futures contracts tied to the Fed’s policy rate now see about a 68% chance of a rate cut at the Fed’s September meeting, up from around 64% previously.
El-Erian said the Fed risks “keeping rates too high for too long” and put the chances of a U.S. recession at 35% and a soft landing at 50%.
He believes that "the more likely mistake the Fed will make right now is not to start cutting rates soon enough" and eventually "have to lower rates lower than they should be."
Some Fed officials have begun nervously watching a slowdown that could sweep through the economy and soon hit the labor market, worrying that keeping interest rates too high for too long could cost American workers through slower growth.
So far, hiring has remained strong, and wage growth, while cooling, remains robust. Still, some indicators suggest that employment conditions are indeed deteriorating — a notable decline in job openings, a modest increase in the unemployment rate and a recent rise in claims for unemployment benefits.
San Francisco Fed President Mary Daly said in a speech earlier this week that the U.S. labor market is approaching an inflection point and further economic slowdown in the future could mean higher unemployment. The U.S. non-farm payrolls report for June will be released next week.
She also spoke after the PCE data was released on Friday. Daly said the inflation data released on Friday showed that monetary policy was working, but it was too early to tell when to cut interest rates. She said the Fed will remain data-dependent and highlighted a variety of scenarios that could play out in the coming months. For example, if inflation falls more slowly than expected, the Fed will have to keep interest rates high for longer.
“On the other hand, if inflation were to fall as it did late last year and the labor market remained the same or we had a recession, we could actually adjust policy to respond to that situation ... (but) it’s too early to say that right now,” she added.
The article is forwarded from: Jinshi Data