Fed Rate Cut is Dangerous

From Mohamed El-Erian:

It’s hard to justify a rate cut using traditional metrics. The unemployment rate is at a five-decade low, inflation is not that far below the Fed’s target, financial conditions are the loosest in almost two decades, stock indices are at record highs, and interest rates are already at low levels. Yet the Fed is under tremendous market and political pressure to cut. And it will do so citing the concept of an “insurance cut” – that is, increasing monetary stimulus now in order to reduce the risk of future damage.

But like most insurance you and I get, the one the Fed will embrace is not free for four main reasons:

• The more the central bank does now, the less room it will have to cut later if domestic economic momentum wanes. (Remember, the current US economic expansion is already an unusually long one, having also set a new record less month.)

• The greater the policy easing, the stronger the signal to investors and traders to expand their risk appetite even more – and this at a time when several indicators of excessive risk-taking are already flashing yellow if not red.

• With easing unlikely to have much beneficial economic effects, corporate and economic fundamentals will lag further already-elevated asset prices, thereby accentuating threats of future financial instability that could cause economic harm.

• The more the Fed stimulates when the economy is in a good place, the more it will be seen as succumbing to undue pressures from markets and the White House. This could damage its credibility and undermine the effectiveness of its future policy guidance.

Mohamed A. El-Erian is the chief economic advisor to Allianz, the corporate parent of PIMCO where he served as CEO and co-CIO (2007-2014). A Bloomberg columnist and Financial Times contributing editor, he was Chair of President Obama’s Global Development Council and has authored two New York Times Best Sellers: the 2008 “When Markets Collide” and 2016 “The Only Game in Town.”