El-Erian Fears “The Fed Is Losing Credibility” As Dudley Warns “Hope Is Not A Strategy”

It’s been a lousy year for the monetary wonks at the Federal Reserve that not just predicted transitory inflation but doubled down on the narrative. In April, a forecast for 2.77% year-end inflation has since ballooned to realize that Headline CPI will be 6.31%. And judging by the monthly increases in inflation, estimates may go higher. 

In what could be the most significant miscalculation in decades, Allianz Chief Economic Advisor Mohamed El-Erian warns the Fed is losing credibility over its transitory narrative, according to CNBC. 

“I think the Fed is losing credibility,” El-Erian told an audience Monday at an ADIPEC energy industry forum in Abi Dhabi. “I’ve argued that it is really important to reestablish a credible voice on inflation and this has massive institutional, political and social implications.”

El-Erian said the Fed erred on the side of its inflation stance that wakened the central bank’s forward guidance. He said persistent inflation threatens the Biden administration’s economic agenda and has profoundly impacted the working poor as their real wages evaporated due to soaring prices. 

“So, it is a big issue and I hope that the Fed will catch up with developments on the ground,” he added.

The longer inflation persists, which by the way, Goldman Sachs warned things are going to get much worse before it gets better, the Fed has stumbled into one of the most significant policy errors in decades for not addressing the inflation situation accurately. Goldman expects core PCE inflation, already at 30-year highs, to rise even higher by year-end. 

“We are in this transition of central banks mischaracterizing inflation. The repeated narrative: ‘It is transitory, it is transitory, it is transitory.’ It is not transitory,” El-Erian said, warning the Fed risked making a major policy error.

“We have ample evidence that there are behavioral changes going on,” El-Erian said.

“Companies are charging higher prices [and] there’s more to come. Supply disruptions are lasting for a lot longer than anybody anticipated. Consumers are advancing purchases in order to avoid problems down the road — that of course puts pressure on inflation. And then wage behaviors are changing.”

“So, if you look at the underlying behavioral element that leads to inflation, you come up with the conclusion that this will last for a while. And that’s even before you talk about the renewed Covid disruptions,” he added.

El-Erian worries the Fed’s doubling down of the transitory narrative would mean a more aggressive future policy response: “To accelerate, in December, the pace of tapering.”

He ended the presentation by saying the Fed needs to begin prepping people for higher interest rates, sort of like what central banks from Australia, New Zealand, and Norway have been doing. 

Last month, El-Erian warned there’s a rising probability of the central bank “having to slam on the monetary policy brakes down the road—the ‘handbrake turn,’” which could spark cross-asset volatility from bonds to stocks to currencies. 

Besides El-Erian, Bill Dudley, former president of the Federal Reserve Bank of New York, published another of his infamous post-Fed op-eds in Bloomberg this morning, outlining how the evidence is mounting that monetary policy tightening is needed and that the “Fed is between a rock and a hard place.”

“On one hand, evidence continues to accumulate that the Fed is behind the curve in removing monetary policy accommodation. On the other, the Fed has locked itself in with a regime in which it won’t raise short-term rates until after the tapering of asset purchases is completed in June.”

He said “hope and pray” that inflation abates is not a strategy, warning, “if it waits, the economy could significantly overheat, requiring the Fed to jam on the brakes, precipitating an early recession.”

Dudley goes on to warn of what comes next:

Most likely, it will be resolved by the Fed sitting on its hands and hoping for better news on inflation, labor market supply and inflation expectations. But as my old boss Tim Geithner was often fond of saying, “hope is not a strategy.”

That, in itself, is problematic.

‘Problematic’ is one word for it, Bill.

And former Treasury Secretary Larry Summers, writing in WaPo, admits why such fear is being expressed by establishment types – ‘meddling’ in the independence of The Fed…

Excessive inflation and a sense that it was not being controlled helped elect Richard Nixon and Ronald Reagan, and risks bringing Donald Trump back to power.

While an overheating economy is a relatively good problem to have compared to a pandemic or a financial crisis, it will metastasize and threaten prosperity and public trust unless clearly acknowledged and addressed.