Why the Fed is holding off for now
The Federal Open Market Committee unanimously voted to leave interest rates in the 5.25% to 5.5% range in January after the monthly inflation readings surprised.
The consumer price index inched up 0.3% in January, higher than expected, but employers added a surprisingly strong 353,000 jobs with the unemployment rate remaining unchanged at 3.7%. The economy also expanded at an annual rate of 3.2% in the fourth quarter of 2023, higher than forecast.
"The good news is the labor market and economy are prospering, furnishing the Committee the luxury of making policy without the pressure of urgency,” wrote Atlanta Fed President Raphael Bostic in a recent note.
Bostic expects the Fed’s first interest rate cut to occur in the third quarter of the year, followed by a pause to assess how the policy change affects the economy. But he has concerns that the first hint of an interest rate cut could encourage businesses to boost spending and investment — and inflation will surge once more.
“This threat of what I’ll call pent-up exuberance is a new upside risk that I think bears scrutiny in coming months,” he warns.
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Read MoreEl-Erian says the Fed faces a bumpy road
Although recent economic indicators have led the Fed to remain cautious, El-Erian notes the consumer price index has plunged from the June 2022 high of over 9% to 3.1% last January.
He says the Fed’s approach is similar to driving a car by looking in the rear-view mirror instead of through the windshield. “This type of driving works for straight roads,” he writes. “It is problematic in other situations.”
El-Erian believes the Fed is “highly unlikely to face a straight road from here” thanks to a “tug of war” between goods deflation and high services inflation. Keeping interest rates high for too long could end up creating higher unemployment, instability and output loss — instead of gently nudging the economy into a soft landing.
“Historic data should not be the sole determinant of policy making,” El-Erian says. “This ongoing obsession with the numbers should give way to an approach that also incorporates strategic vision and forward-looking insights on where the economy is heading.”
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