The central bank is meeting on May 7 to determine its next step on interest rates. Currently, markets expect rates to stay the same after the May meeting but a 60 percent chance of a 25 basis-point cut in June, according to the CME Group’s FedWatch. Such expectations reflect “how they have been trained repeatedly by the Fed to expect looser financial conditions the minute there are any signs of unusual market volatility,” the economist Mohamed El-Erian wrote in a Bloomberg op-ed last week.
El-Erian, the former CEO of the investment management firm PIMCO, argued that the Fed should not cut rates too soon because “lessons from central banking history suggest that when faced with both parts of the dual mandate going against it, the Fed should give priority to putting the inflation genie back in the bottle.”
Curbing inflation is especially critical given that the Fed enters the current economic turbulence with “credibility eroded by the misguided 2021 transition inflation judgment,” El-Erian wrote. After the U.S. emerged from Covid lockdowns and consumer prices surged, Powell described the inflation spike as “transitory,” expecting it to ease quickly. Instead, price increases persisted and remained stubbornly above the Fed’s 2 percent target, even after aggressive interest rate hikes.
With that credibility weakened, El-Erian argued, it’s all the more important for the Fed to demonstrate that it takes its inflation mandate seriously. To its credit, the central bank has so far avoided a knee-jerk reaction to recent stock market volatility and a growing inflow of recession expectations from Wall Street’s top economists.
