Economist says Federal Reserve too slow to cut interest rates and weakening the economy

The U.S. labor market slowed down in July and looked weaker than expected, creating 114,000 new jobs. The unemployment rate also ticked up to 4.3 percent. It’s raising questions about whether the Federal Reserve has waited too long to cut interest rates. Economist Mohamed El-Erian is among those who have been very vocal about this. He joined Geoff Bennett to discuss his concerns.
Geoff Bennett:
The U.S. labor market slowed down notably last month and looked weaker than expected, creating just 114,000 new jobs. That’s down significantly from the average of 215,000 jobs a month over the past year. The unemployment rate ticked up again to 4.3 percent. That’s the highest since late 2021.
The reaction to today’s report is raising questions for the second time in as many days about whether the Federal Reserve has waited too long to cut interest rates.
Economist Mohamed El-Erian is among those who have been very vocal about this. He’s the president of Queens College, Cambridge University, and the chief economic adviser at Allianz. And he joins us now.
Thanks so much for being with us.
Mohamed El-Erian, Chief Economic Adviser, Allianz:
Thanks for having me.
Geoff Bennett:
First, a question about this jobs report. What do it and recent economic data tell you about where the economy is right now?
Mohamed El-Erian:
They tell us that the economy is weakening in a much broader and much faster rate than most people expected, including the Federal Reserve.
Geoff Bennett:
Is this weakening or slowdown the direct result of the Fed’s strategy of keeping interest rates high to fight inflation?
Mohamed El-Erian:
It is. And it was meant to slow the economy. The question is, do you get a normalization or do you get something worse? Or to use the economic language, do you get a soft landing, where you sacrifice some growth, but it’s worth it for bringing down inflation, or do you get a recession, where you damage Americans’ well-being even more after having hit them with very high price increases?
A set of data that we have had recently, as well as what you’re hearing from companies, suggests that this is beyond the normalization. So you have got two concerns right now, and you see this in the marketplace. One is about the growth scare and the second one is about another policy mistake by the Fed.
Geoff Bennett:
Does this raise the specter of a recession further down the line in your view?
Mohamed El-Erian:
So my probability for a recession is about 35 percent. So it’s not the dominant scenario, but we have got to be careful.
A recession would really damage the economy and would be particularly for low-income households. They are already suffering, Geoff. They’re suffering from having run down all the pandemic savings. Hiring is slowing down. Their credit is maxed out. So the last thing you want to do is unduly damage the labor market, because that’s the only source of income.
There are no other buffers now for the low-income households.
Geoff Bennett:
Was the Fed late in recognizing this slowdown, this weakening, as you have described it?
Mohamed El-Erian:
Yes. And it’s the second big policy mistake, in my opinion, since we have had the pandemic. The first one now is broadly recognized. They called inflation transitory, when it was something much worse than that, and, therefore, they were slow in moving against inflation.
And now I fear that they are slow in moving against economic weakness. So if they’re not careful, they will end up making both mistakes in one cycle.
Geoff Bennett:
What kind of cut should we expect at the September meeting? Are we looking at a half-point or a quarter-point cut in the interest rate?
Mohamed El-Erian:
And that was remarkable, because, as of two or three days ago, the narrative in the marketplace was, oh, they have time. Only a handful of us were warning that they should start immediately.
Now, suddenly, the market has priced in a 70 percent probability of a cut by half-a-percentage points. Now, normally, the Fed cuts by quarter-percentage points. So if it starts with half-a-percentage point, that is quite a signal. My gut feeling is they won’t do that, is they will cut by a quarter-percentage point?
But 70 percent of the marketplace believes that it will be more than that.
Geoff Bennett:
Something in particular in this jobs report struck me and our team here. It’s that those unemployed for 27 weeks or more now totaled 1.54 million people. This is the most since February of 2022.
Can people hope for a significant uptick in hiring if the Fed starts making these interest rate cuts? Are the two connected?
Mohamed El-Erian:
It will take time. One of the accepted elements about monetary policy is that whether you raise interest rates or you cut interest rate, this acts with long and variable lags.
So it doesn’t have any immediate effect. In fact, we are still feeling the consequences of what was an enormous increase in interest rates in a very short period of time, over 5 percentage points that had to be done very quickly because the Fed fell behind. So it will take time to feel the impact of the cut.
And I’m glad you focus on this point of longer-term unemployment, because what we know from history is the longer you are unemployed, the more unemployable you become. And that is a real social, economic and political issue.
So it is important that we avoid long term unemployment going up even higher.
Geoff Bennett:
Mohamed El-Erian, always a pleasure to speak with you, sir. Thanks for being with us.
Mohamed El-Erian:
Thank you.