A forward-looking Fed would cut rates in July, says Mohamed El-Erian

The Fed should be gearing up for a July rate cut but instead chooses to sit on its hands because of an arbitrary inflation target, says Queens’ College president Mohamed El-Erian.

In an interview with Bloomberg, El-Erian said imminent rate cuts are needed because “the economy is slowing faster than most economists expect and faster than what the Fed expected.”

That slowing economy “has few buffers,” El-Erian explained. “A forward-looking Fed would certainly have the possibility of a July rate cut on the table.”

As El-Erian noted before, the Fed isn’t forward-looking but rather a “play-by-play commentator” that always seems to be one step behind making decisions the economy needs.

Thanks to resurgent inflation, the Fed has practically ruled out any possibility of a July rate cut. Instead, policymakers penciled in only one rate cut this year, most likely in the fall.

But even that decision depends heavily on whether inflation will inch closer to the central bank’s 2% target.

In El-Erian’s view, the U.S. could already be in a recession before the Fed decides to cut rates. Economists think there’s a 35% probability the Fed will trigger a recession by waiting too long.

Despite El-Erian’s criticisms, there’s a chance the Fed can have its cake and eat it, too—that is, taming inflation and cutting interest rates.

Progress on inflation

In recent months, inflation has moderated in everything from producer prices to consumer costs. This is a welcome sign for the Fed that, just a few months ago, was addressing stagflation fears.

The most encouraging sign came on June 28, when the Fed’s favorite inflation gauge, the core Personal Consumption Expenditures (PCE) index, posted its smallest monthly increase since late 2020.

Core PCE, a measure of inflation that excludes volatile food and energy prices, rose by less than 0.1% in May. Compared to a year earlier, the index edged up 2.6%, the slowest increase since March 2021.

Scott Anderson, BMO Capital Markets’ chief U.S. economist, referred to the data as a “sharp slowdown in core inflation,” which is “just what the doctor needed to keep the economy on the soft-landing path.”

A “soft landing” refers to the Fed’s ability to cool inflation without tipping the economy into a recession—a monetary balancing act resting on careful and gradual policy changes.

Experts say a few more months of softening inflation should reinforce the soft landing narrative, opening the door to multiple rate cuts.

“The deflation in goods prices and weakness we are starting to see at least gets us a path to a possible September rate cut,” said KPMG’s chief economist, Diane Swonk.

Seema Shah, Principal Asset Management’s chief global strategist, said the latest PCE data “is a relief” for the Fed, but more progress is needed to justify cuts.

“A further deceleration in inflation, ideally coupled with additional evidence of labor market softening, will be necessary to pave the way for a first rate cut in September,” Shah said.