The Federal Reserve has lost its credibility over its call on inflation, Mohamed El-Erian told Bloomberg.
Now, it must choose between sending the economy into a recession or letting inflation run high, he said.
There is a high probability that the Fed makes a policy mistake, El-Erian said.
Famed economist Mohamed El-Erian doesn't think there's an optimal, soft-landing outcome for the Federal Reserve as it tries to tame inflation, and that it is facing a lose-lose situation.
"The whole point of forward policy guidance by the Fed is to bring along the markets in an orderly fashion," El-Erian told Bloomberg on Tuesday. "Instead, we're seeing the markets run away further from the Fed and do so in a disorderly fashion, and that is why the risk of a policy mistake is so high."
Markets have lost trust in the Federal Reserve over its bad call on inflation through the pandemic, the economist explained. Now, the Fed doesn't have credibility when it comes to fighting inflation, forecasting inflation, or dictating the policy narrative.
"If the Fed ends up validating what the market is now sort of tempting it to do, the Fed will end up breaking something in the economy. But if the Fed doesn't validate what the market has done, the Fed will not reestablish its inflation credibility. That's the lose-lose outcome…that I've been worrying about since last summer."
Volatility has seized markets since the Fed first signaled it would hike interest rates, but uneven messaging from the central bank has caused investors to become even more skittish.
El-Erian said the Fed keeps flip-flopping between hawkish and dovish signals, so he isn't sure what to expect. However, El-Erian said he'd err on the side of high prices over a recession as the preferred outcome of the Fed's actions.
"Now that you're in this position and you're going to end up making a mistake, which is a high probability outcome, I'd rather make a mistake of letting inflation persist than throw this economy into recession," El-Erian said.
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