The Fed could tip the US into recession if it waits too long to cut rates, Mohamed El-Erian says

• The Fed should not keep waiting to cut rates, Mohamed El-Erian wrote in the Financial Times.
• He said such a delay could eventually prompt an aggressive cutting cycle, increasing recession risk.
• El-Erian compares it to when the Fed insisted on not raising rates in 2021, but then had to sharply tighten.

The Federal Reserve's holdup in cutting interest rates may be putting the US economy in jeopardy, Mohamed El-Erian wrote in an op-ed for the Financial Times.

Getting to the first rate cut sooner than later is necessary if the central bank wants to minimize recession risk, the famed economist said. But instead, the Fed has kept insisting on delaying, raising the odds that it will have to pursue a much more aggressive cutting cycle down the road.

"If, this time around, the Fed is forced into a large cutting cycle due to a delayed start and accelerating economic and financial weaknesses, it would also have to end up cutting by more than necessary based on longer-term conditions," El-Erian warned.

This is similar to the Fed's policy mistake in 2021, when officials held back on raising rates as post-pandemic inflation ballooned. However, their argument that inflation was "transitory" proved incorrect, and rates were tightened sharply.

In El-Erian's telling, the policy overshoot "exposed pockets of financial vulnerability and, internationally, the policy challenges facing many other countries."

This time around, Fed officials want to see more disinflationary data before lowering rates. Cutting too soon, the argument goes, could allow inflation to rebound; against a slowing economy, this could mean a stagflationary spiral.

But El-Erian has consistently called out the bank's overdependence on data, and noted that the higher-for-longer rate regime is creating and deepening vulnerabilities in the economy. Included are eroded balance sheets among consumers and small business, alongside climbing household debt.

Earlier this month, he said the Fed's plan to cut just once in December was too late, and could cause the economy to slow more than it should. El-Erian sees recession risk at 35%.

"In my opinion, 'too late' is what was reflected in yesterday's SEP or dot plot," he said, referencing the Fed's Summary of Economic Projections. "By that time, the lagged effects of what was a significant increase in rates would be biting even more."