Renowned economist Mohamed El-Erian says the Fed needs to decide whether it wants to throttle the economy to get inflation back to the target rate.

• Mohamed El-Erian said that by the end of the year, the Fed will choose between the economy and its inflation target.
• The Center will decide whether it can tolerate inflation of 3% or more, above its 2% target.
• Or the Fed will choose to “crush” the economy to reach its long-term goals, he told CNBC.

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According to top economist Mohamed El-Erian, the Federal Reserve needs to make a key decision at the end of the year that will determine whether the US economy will collapse or not.

In an interview with CNBC on Tuesday, Allianz’s chief economic adviser pointed to the market’s overly optimistic stance on inflation, with consumer prices rising 3.7% in August despite a warmer-than-expected inflation report.

But El-Erian warned that the decline in inflation will be “much more complicated”, estimating that headline prices will rise by 60 to 70 basis points, while core inflation will also be “less well-behaved” than expected.

“At the end of the year the Fed will have a choice: You live with 3% or higher inflation, or crush the economy,” he said, adding that he hoped the Fed would not crush the economy.

El-Erian said the US can live with inflation above 2% as long as it is stable and described the 2% target as “completely arbitrary”.

He expects the Fed to push its deadline to reach 2% inflation into the future until it eventually reaches the higher target.

In the meantime, the stock market will have to absorb the possibility that rates will remain high for a long time, he said.

“The market has assumed the Fed will cut rates early next year. I don’t think that’s going to happen,” El-Erian said.

According to the CME FedWatch tool, markets are currently pricing in a 37.8% chance that interest rates could rise above their current levels by June 2024.

Meanwhile, the New York Fed has given a 61% chance that the economy could fall into recession by August next year.

Although central bankers are officially aiming to reduce inflation to a 2% long-term target, doing so could lead to a severe downturn in the US economy, El-Erian previously warned.

Source