• By the end of the year, the Fed will decide between the economy and its inflation target, said Mohamed El-Erian.
  • The central bank will decide whether it can tolerate inflation of 3% or more – above its 2% target.
  • Or the Fed will choose to “break up” the economy to achieve its longstanding goal, he told CNBC.

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According to top economist Mohamed El-Erian, the Federal Reserve must make a crucial decision at the end of the year that will determine whether the US economy collapses.

In an interview with CNBC on Tuesday, Allianz’s chief economic adviser pointed to the market’s overly optimistic stance on inflation, even though August’s inflation report came in hotter than expected and consumer prices rose 3.7%.

However, El-Erian warned that the decline in inflation will be “much more complicated,” predicting that headline prices would rise another 60 to 70 basis points, while core inflation would also likely be “less subdued” than expected.

“At the end of the year, the Fed will face a choice: live with inflation of 3% or more or destroy the economy,” he said, adding that he hopes the Fed doesn’t put pressure on the economy.

The U.S. can live with inflation above 2% as long as it is stable, El-Erian said, calling the 2% target “completely arbitrary.”

He expects the Fed to push its timeline for reaching 2% inflation further and further into the future until it eventually moves to a higher target.

In the meantime, the stock market will have to cope with the prospect of interest rates staying higher for longer, he added.

“The market has assumed that the Fed will cut interest rates early next year. I don’t think that will happen,” El-Erian said.

Markets are currently pricing in a 37.8% chance that interest rates could be above current levels by June 2024, according to the CME FedWatch tool.

Meanwhile, the New York Fed has priced in a 61% chance that the economy could slip into recession by August next year.

Although central bankers are officially aiming to lower inflation to a long-term target of 2%, this could trigger a severe downturn for the US economy, El-Erian previously warned.

Source : www.businessinsider.com

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