El-Erian Sees No Reason For Recession 'Unless There's Another Policy Mistake,' Predicts Fed Pause This Month

As the Federal Reserve’s next rate-setting meeting approaches, an economist weighed on the near-term policy direction and possibility of a stagflation in the U.S.

What Happened: The Fed will not raise rates in the September meeting, going by the economic data and the fact the Fed is highly data-dependent, said Mohamed El-Erian, chief economic adviser at Allianz, in an interview with CNBC.

The Fed’s monetary policy-setting arm, the Federal Open Market Committee, is meeting for a two-day monetary policy meeting on Sept. 19-20.

El-Erian noted that the market sees a 90% probability that the Fed will keep rates at the current level of 5.25%-5.50%. “But what they will do is keep the door open for at least one more rate hike in the future,” he said.

The economist premised his expectations on two factors. The economy is proving to be stronger than they had anticipated, he said. He expects the Fed to increase the GDP forecast for the year from a median of 1% to 2%

Secondly, there have been supply-driven major moves in oil and certain food items and that is going to go into the headline inflation, he added.

“So they aren’t going to hike this month but they are going to keep the door open to the possibility of hiking again,” El-Erian said.

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China Impact: Commenting on the Chinese economy and the impact of its slowdown on the global economy, El-Erian said he does not expect China to recover anytime soon.

The growth problems are compounded by debt problems and they can be addressed only by structural measures and not short-term stimulus, he said.

While China is not expected to bounce back anytime soon, oil prices will remain high because at the moment with oil prices it is not a demand problem but a supply problem, the economist said.

“I think we have to increasingly acknowledge that the issue facing us is on the supply side,” he said, adding “We just don’t have enough supply and that’s why we see prices being so stubborn.”

U.S. Better Positioned: El-Erian said the U.S. will be able to handle the scenario arising from the supply-side shocks to inflation. “There is no reason for us to fall into a recession unless there’s another policy mistake,” he said.

The economist, however, sees the possibility of stagnation in the euro area and the U.K. as they do not have a dynamic economy.

“They don’t have the ability to reallocate resources and they don’t have the vision for growth that we have. So, I worry less about stagflation in the US, but I do worry about stagflation in the Eurozone and in the U.K.,” he said.

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Photo by International Monetary Fund on Flickr