LOS ANGELELS.–Former PIMCO co-CEO and 65-year-old Allianz chief economic consultant Mohamed El-Erian said he worries about the Federal Reserve Board reducing the 3.4% inflation rate, 1.4% about the Fed’s long –term target of 2%. El-Erian said the Fed finds itself in a dilemma wanting to reduce interest rates now at 5.5% percent after nearly over 18 months of rate hikes. Worried that high interest rates could causedisinflation or worse yet deflation, El-Erian doesn’t think the Fed’s Open Market Committee [FOMC] will lower interest rates at its March meeting. With the inflation rate at 3.4%, it’s difficult for Fed Chairman Jerome Powell to accelerate interest rate cuts, fearing that it could spur more inflation. Since Covid-19 is in the rearview mirror, El-Erian thinks there’s more consumers using the service economy like restaurants and travel, not making big purchases like cars or remodeling. At the end of the day, cash keeps pouring into the M1 money supply.
So, the dilemma for consumers, especially those saddled with credit card debt, is that they can’t afford to meet obligations like mortgage and rent payments, while paying high interest rates on mortgages and consumer debt. El-Erian differed from many economists, believing pent up demand for travel and dining out has fueled the 3.4% inflation rate, making it difficult for Powell to start rate reductions. “It’s not [disinflation]. We’re going to see and already are seeing cost push pressures in the pipeline,” El-Erian told Bloomberg. “I suspect that we will see inflation at the CPI level get stuck at 3%, one percent higher than the Fed’s target.” El-Erian doesn’t see a slowdown in consumer spending any time soon, maintaining an inflation rate above the Fed’s target. Geopolitical events in the Red Sea, with Biden attacking Yemen’s Houthi rebels, could triggers more inflation in the auto sector where supply chains disruptions and transportation costs to raise prices.
El-Erian also sees increases in unit labor costs fueling more inflation, especially if consumers come out of hibernation and begin spending more. With unemployment at record lows, it puts more cash into consumers’ pockets, also adding to inflation. Tight labor markets push unit labor costs up keeping pressure on inflation, something the Fed would like to see stop. But El-Erian worries that if Powell pushes the Federal Funds Rate [5.5%] up any higher, it’s going to prevent rate cuts, something expected by Wall Streets. Watching markets move sideways shows that consumers continue to spend robustly in the consumer economy. Workers can usually demand more compensation when shortages in the labor market persist, preventing the Fed from slashing rates, something sought by Wall Street. El-Erian sees more consumers coming out of the woodwork, spending more cash on consumer purchases, something that’s fueled more inflation.
Watching the Dow Jones Industrial Average and S&P 500 hit record highs shows that investors see any end in sight to the current bull market. But Powell knows that markets are very fickle and can see wild swings in the market daily. Powell knows that the weeks-long rally in the bond market reflects the fact that investors see the Fed slashing interest rates in the near future. El-Erian sees Powell caught between a rock and a hard place, unable to slash rates when unemployment remains at historic lows, with consumers digesting high interest rates. When Wall Street digests the fact that Powell has put rate cuts on hold, it’s going to fuel a sell-off on Wall Street. Once markets see that rates cuts aren’t happening anytime soon, El-Erian sees a market sell-off. Without some measure of economic weakness, it’s difficult for the Fed’s Open Market Committee to start cutting rates when they know they’ll have to start raising rates again.
El-Erian doesn’t see a scenario in which the FOMC would start hiking rates again, knowing the drag on an already sluggish economy. Higher rates would crush the bond market and fuel an exodus in equities, leaving the economy with a lowered Gross Domestic Product [GDP]. “But this notion that immaculate disinflation is going to continue, is something I find very hard to reconcile with actual data,” El-Erian said. Disinflation or deflation won’t happen in low unemployment environment where more consumer have cash to spend in the consumer economy. El-Erian fears that more consumer spending due to low unemployment could fuel to more inflation. If markets head south, it would convince the FOMC to consider slashing interests rates in the near term. El-Erian, and Powell for that matter, can’t control geopolitical events like 81-year-old President Joe Biden bombing Houthi rebels or a continuation of the Ukraine War.
All signs at least now point to the FOMC delaying rate cuts until they measure a reduction to the GDP. Powell can’t placate Wall Street by slashing the Federal Funds Rate when the inflation rates runs at 3.4%. If the inflation rate goes any higher, Powell could ratchet up rates once again, potentially killing the recent bond market rally. New York Fed thins that there’s 63% in 2024 of recession, in which case the bond market would keep rallying, while stocks begin to slide. El-Erian worries that the Fed has made slashing rate next to impossible by seeing GDP continue to rise at over 3%. If the FOMC sees no reduction in inflation, it will put rate cuts on indefinite hold. Geopolitical events in the Mdeast and Ukraine could trigger a recession in 2024, triggering an end to the bull market. Powell must see disinflation or deflationary pressures before ordering rate cuts, something that could happen with a wider conflict in the Mideast.
About the Author
John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He’s editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.
