Mohamed El-Erian shares 2 reasons why Fed policy must serve the real economy, not just financial markets

The Federal Reserve must shift its monetary policy to the real economy because it plays to the tune of financial markets, according to Mohamed El-Erian.

The investors feel entitled to loose financial policy and low interest rates, which is good for the stock market. The top economist said in a Financial Times op-ed that high inflation has become difficult to contain.

Central banks have little choice but to place market considerations in the face of price increases that undermine standards of living, erode the future growth outlook and hit the most vulnerable segments of society.

According to El-Erian, the Fed has been late in recognizing price instability, which might make managing orderly disinflation problematic. He thinks the US central bank should have changed a year ago.

He said markets came to expect looser financial conditions whenever there was a strong whiff of instability.

The Fed raised rates by a quarter-point in March, taking its biggest step yet to cool inflation and bring an end to the near-zero rates of the pandemic era. Markets are pricing in a 50-basis point hike from May. El-Erian said that this scenario is likely to be a bigger policy mistake than misjudging inflation, as the Fed risks pushing the economy into a recession.

He said that if the Fed fails to confirm what the market has priced in, it would make inflation last even longer.

He said that this would undermine inflation expectations and cause the inflation problem to persist well into the future.

If the Fed changes its policy over the next two years, it will be worse. El-Erian said that doing that would weaken its institutional standing and fail to return monetary policy to the service of the real economy.

He said that it would probably prove to be a fleeting victory for those in the markets.

The economist has warned that the Fed's ultra-loose money conditions could lead to a recession.

The time has come to return monetary policy to the service of the real economy. The alternative of not doing so would be more problematic.

A chief strategist at a $1.2 trillion real estate investing giant breaks down the odds of a housing crash in a report.