Is the Federal Reserve (Fed) about to make a critical policy mistake? That is the question being raised by some strategists and economists as the Fed nears the end of its hiking cycle. Despite optimistic and positive market performances this year, with the S&P 500 rallying over 17%, concerns about potential Fed missteps continue to linger.
According to Mohamed El-Erian, the Allianz advisor and president of Queens’ College, Cambridge University, there is still room for the central bank to make a policy mistake. He has consistently emphasized the strength of the U.S. economy while warning against the consequences of such a mistake.
El-Erian’s fear lies in the Fed overtightening and continuing to pursue a 2% inflation target that may not be suitable considering the current structural and supply-side elements. He believes that the Fed’s data dependence is problematic, as it relies on backward-looking data that may not accurately reflect the current economic situation.
Market participants share concerns about the Fed, but their worries have been tempered by the surprising resilience of both the markets and the economy this year. Despite the potential for the Fed to restrict growth, the economy has not been significantly affected by the sharp increase in rates from zero to 5.5% in just over a year.
While some experts caution against an overzealous Fed, others believe that the situation may not be as clear-cut. Jack Manley, global market strategist at JPMorgan Asset Management, points out that historically, every recession in the past 60 to 70 years has happened due to an excessive response from the Fed. However, he believes that this time might be different, at least in the first half of next year.
Investors may not be overly concerned about the Fed’s actions at the moment because they are already looking ahead to potential rate cuts. The Fed’s June summary of economic projections indicated that rates are expected to be lower by the end of 2024. Market participants align with these projections, with the majority of futures bets pricing in a range of 3.75% to 4.25% by December of next year.
Overall, concerns about the Fed’s policies persist, but current market performance and future rate cut expectations have somewhat alleviated anxieties. Nevertheless, experts like El-Erian continue to highlight the need for the Fed to take a long-term view and ensure that decisions are not solely based on short-term data.
