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Economist El-Erian Sees Strong Chance for Recession

But he thinks the Fed must keep raising interest rates to quell inflation. And he expects continued market volatility.
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More than a year before the Federal Reserve began raising interest rates, economist Mohamed El-Erian warned about the danger of inflation.

The Fed finally started lifting rates in March and is now moving in a big way—75 basis points at each of its last three meetings.

But continued aggressive rate hikes risk triggering recession, says El-Erian, former chief executive of money manager Pimco and formerly head investment manager of Harvard University’s endowment. He is now president of Queen’s College in Cambridge, England.

Looking at financial markets, El-Erian doesn’t foresee a quick rebound for stocks and bonds. Here is what he told in a Sept. 26 e-mail interview. Do you approve of how the Fed is handling its interest-rate increases?

El-Erian: The Fed is in a deep hole, much of its own making. Having been seduced last year by the concept of transitory inflation and having fallen asleep at the policy wheel, it is now forced to hike aggressively into a slowing economy.

The possibility of a soft landing has given way to the uncomfortably-high risk that the Fed will tip the economy into recession. The alternative of pivoting away from rate hikes is not a good one, as it risks the persistence of stagflation well into 2023.

Our inconvenient reality is that because the Fed has been so late, the U.S. no longer has a first-best policy option available. [El-Erian favors continued rate increases to subdue inflation.] Do you think the Fed's forecasts for economic growth and inflation are realistic?

El-Erian: They have become less unrealistic over time, but I fear they are still overly optimistic.

It is troubling that, quarter after quarter, the Fed has been forced to revise its forecasts in the same direction – lower growth and higher inflation. Moreover, these revisions have not been small.

In the most recent quarterly forecasts, the Fed adversely changed its projections for growth, unemployment and interest rates in 2022-24. And it did so for core inflation in 2022-23.

[In September, the Fed forecast economic growth of 0.2% in 2022, 1.2% in 2023 and 1.7% in 2024. The forecast for inflation is 5.4% for 2022, 2.8% for 2023 and 2.3% for 2024.] Do you think we'll have a recession in the next 18 months?

El-Erian: It’s not a done deal, but it certainly is a high risk. Much will depend on the policy response from here. What's your outlook for stocks and bonds?

El-Erian: We should expect continued volatility. For a while, markets have been navigating three simultaneous regime changes: in global liquidity, in global growth, and in the nature of globalization. That is being amplified by some market-functioning issues and the accelerated loss of confidence in policymakers. What's your outlook for currencies?

El-Erian: I have been warning for the last few years against fading the dollar and still feel the same way, despite its significant appreciation. The time will come for other currencies to shine. But for now, the dollar retains favorable differentials with respect to interest rates, growth and safe-haven status. What's your outlook for commodities?

El-Erian: The general theme is softening demand. Supply-side issues, however, vary greatly depending on the commodity. Some commodities have supply shortages that limit price declines, and in a few cases can push prices higher. But other commodities have burgeoning supply that will accentuate the downward price pressure coming from weakening demand.