Stop-Start Federal Reserve Needs a Rethink, Says El-Erian

Image: IMF, sourced: IMF on Flickr, licensing: CC 2.0. Photo by Ryan Rayburn.

The U.S. Federal Reserve's approach to setting monetary policy is "volatile", and a rethink of strategy is needed.

This is according to one of the world's most prominent economists, Mohamed A. El-Erian, former head of PIMCO and current chief economic adviser at Allianz, one of the world's biggest bond traders.

His call comes after members of the Federal Reserve signal caution on further interest rate cuts as they react to recent above-consensus U.S. labour market and inflation data.

This, mere weeks after voting for an unusually generous 50 basis point interest rate cut.

"Excessive data dependency has contributed to volatility not just in the Federal Reserve's forward policy guidance but also actual policy steps," says El-Erian.

He summarises the Fed's stop-start approach to interest rates:

- End July: no rate cut due to data
- Mid-September: a jumbo 50 bps rate cut due to data
- Mid-October: an inclination towards “rate cut caution” due to data.

"This type of volatility has not been limited to the last three months. It has persisted for some three years now. Hopefully, the early signs of a Fed shift to combining data dependency with more of a strategic approach will take hold," says El-Erian.

The Fed's reactive messaging and actions have contributed to USD volatility in recent months. The USD fell to multi-year lows against a host of currencies into and after that 50bp cut.

It has since recovered as FOMC members pull the reins.

The U.S. economy has printed better-than-expected data in August and September, with the labour market continuing to add jobs and inflation starting to tick higher again.

FOMC member Christopher Waller said on Monday this means more caution on interest rate cuts was needed going forward.

FOMC member Neal Kashkari said that it would be appropriate to consider modest rate cuts going forward, and the Fed is on the edge of the 2% inflation target.

Last week, the FOMC's Raphael Bostic said, "I am totally comfortable with skipping a meeting if the data suggests that's appropriate".

Colleague Mary Daly said there was room to keep interest rates unchanged next month, saying, "one or two more rate cuts are likely this year".