El-Erian Sees Fed Having Three Primary Options For Interest Rates Ahead, Believes None Is Optimal

Allianz chief economic adviser and noted economist Mohamed El-Erian reportedly said that the Federal Reserve has three primary options for interest rates but none of them is optimal.

In an opinion piece published in Financial Times, El-Erian said there are two issues with the expectations that the central bank will skip rate hike this time, with an inclination to commence tightening in July.

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An additional month of data may not significantly enhance the Fed's understanding of the impact of a policy tool that acts with variable lags, he wrote. ‘Second, recent data favours a hike for a central bank that has repeatedly insisted that it is "data dependent,"' he argued. ‘No wonder some other Fed officials favour a hike this week,' El-Erian said.

Wall Street has reflected optimism over a potential pause in the June policy. According to the CME FedWatch Tool, traders are factoring-in an 81.5% probability that the Fed will maintain a status quo. The SPDR S&P 500 ETF Trust SPY closed 0.91% higher on Friday while the Invesco QQQ Trust Series 1 QQQ rose 1.69%, according to Benzinga Pro.

Inflation: El-Erian added that unless the CPI inflation scheduled to be released on Tuesday indicates significant weakness, a "skip" would render future decisions even more challenging.

"If the central bank is genuinely data dependent and truly committed to achieving its current inflation target of 2%, it should raise rates by 0.25 percentage points and leave the door open for additional hikes," El-Erian wrote.

He said if the Fed believes it has an outdated inflation target because of significant changes on the supply side of the economy — and that the modification of the target needs a lengthy and delicate process — then it should choose to pause with an inclination to cut when appropriate.

This would allow the effects of the earlier rate hikes to permeate through the economy while reducing the possibilities of undue hit to economic growth and unsettling financial instability, he said.

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