Here’s what the Fed should say to curb market volatility amid bank tremors, sticky inflation, and higher rates, according to Mohamed El-Erian

Mohamed El-Erian

Mohamed El-ErianMohamed El-Erian

  • Mohamed El-Erian broke down in an op-ed how the Fed should talk about its economic outlook.

  • Markets are highly sensitive to policy statements from the US central bank right now.

  • The Fed should address banking sector issues, high inflation, and stay open to further tightening.

The Federal Reserve is expected to deliver another interest rate hike on Wednesday, with chair Jerome Powell holding a press conference on the US central bank’s policy decision right after.

Often, the meeting and press conference from Powell are followed by large price swings in the market as investors try to digest what’s next for the economy.

In a Bloomberg Opinion column, Mohamed El-Erian writes that the Fed should relay three things in order to curb volatility in an economic environment with stubborn inflation, bank tremors, and higher rates.

First, the Fed should acknowledge that “while there still is a range of plausible outcomes, there is enough evidence to confirm that the economy is weakening and that the job market is loosening,” El-Erian says. “Yet inflation is not yet under sufficient control, judging not only from the stickiness of core inflation but the recent edging up of inflationary expectations.”

Large price swings typically occur around the Fed’s policy announcements. “Market volatility is three times higher during press conferences held by current Chair Jerome Powell than those held by his predecessors, and they tend to reverse the market’s initial reactions to the Committee statement,” a study from the Center for Economic and Policy Research released last month reads.

Second, El-Erian says the US central bank should address turmoil in the banking sector, adding that the risk of “further bank failures [have] not been extinguished” and are “likely to undermine the extension of credit to the economy.”

El-Erian added: “It should also clarify that an increase in credit risk would aggravate what has until now mainly been related to interest-rate risk.”

It’s important that the Fed notes that this doesn’t mean the banking system as a whole is facing an existential crisis. It’s not the largest US banks that will take immediate hits. Instead, these issues are concentrated in smaller and regional firms.

Three regional banks have failed in the past two months, sparking a crisis of confidence in the sector. This was kicked off with the collapse of Silicon Valley Bank in March, the second-largest banking failure in US history at the time, a record overtaken by the failure of First Republic Bank earlier this week.

Finally, the Fed should keep open the possibility of further tightening so that markets don’t immediately price in odds that borrowing costs are done rising.

“It should also signal that its approach to this rate cycle will increasingly shift away from the current approach of heavy data dependence to a more strategic approach underpinned by the expected longer-term secular evolution of the economy,” El-Erian says. “This would include the revamping of its outdated monetary policy framework.”

Read the original article on Business Insider

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