According to Yahoo News, economist Mohamed El-Erian has suggested that market exuberance in pricing lower interest rates may actually hinder the Federal Reserve from making its long-awaited dovish pivot. In an article for the Financial Times, El-Erian explained that the market's affinity for rate cuts loosens financial conditions and heightens the Fed's concerns about inflationary pressures, thereby delaying the rate cuts that the markets are betting on.
Bets on monetary policy easing in early 2024 have led to the largest monthly loosening in conditions on record in November, with equities soaring and Treasury yields dropping across the curve. This is despite cautious statements from key Fed officials, including Chairman Jeremy Powell, who warned that it would be 'premature' to consider policy restrictive enough and that the Fed was prepared to keep tightening if necessary.
El-Erian also suggested that markets may currently believe the central bank will tolerate a 3% inflation rate instead of its 2% target, which would ease the need to keep interest rates elevated. He warned that pursuing too low an inflation target in this environment would result in unnecessary sacrifices in growth and livelihoods, as well as a worsening of inequality.
The economist also noted that the Fed may have lost credibility due to forecasting errors, delayed policy, and supervisory lapses during the hiking cycle. Additionally, markets have not had a strong track record for predicting a Fed pivot, as a dovish turn has been priced in six times since the COVID-19 pandemic. Recessionary fears could also play a role in market behavior, although this would not explain the surge in equities but would align with developments in gold and oil markets.
