- Markets are gearing up for a Fed policy mistake if it raises rates aggressively, Mohamed El-Erian told CNBC.
- "The market is pricing in a higher probability of a Fed policy mistake," the economist said Thursday.
- The Fed now being forced to move quickly on policy is one of the most avoidable situations, he suggested.
Economist Mohamed El-Erian thinks the market is bracing for another Federal Reserve policy blunder, in light of new inflation data that has further raised expectations for aggressive interest-rate hikes this year.
US stocks fell at Thursday's close after the US Consumer Price Index report showed a rise of 7.5% in January, compared with the 7.3% jump expected. That was the strongest growth since February 1982.
After the inflation reading, St. Louis Fed President James Bullard, a voting member of the Fed's rate-setting committee, said he's become "dramatically" more hawkish. He now wants a rate increase of 100 basis points — a full percentage point — by July.
CNBC asked El-Erian whether it would be an acknowledgement by the Fed that it had made a blunder, if it went ahead with the move Bullard suggested.
"This will be the second admission of a policy error," he told CNBC in a Thursday interview. "The first one was on November 30, when they finally retired 'transitory,' having miscalled inflation for so long."
"And now this policy error would be of starting to slam on the brakes because they didn't take the foot off the accelerator early enough," he added.
El-Erian, the chief economic adviser at Allianz, has previously called out the Fed for sticking to its view of US inflation as "transitory," despite a series of high monthly readings.
This time, he said if the Fed moves quickly on rate decisions, it will end up in a "lose-lose" situation for the US stock markets and the economy.
"So the market is pricing in a higher probability of a Fed policy mistake," he said.
El-Erian's view already seems to be reflected in the market. Analysts have noted a growing conviction of an increase in the Fed's target range for its policy rate to 1% to 1.25% by the end of its June meeting, with some betting on even steeper hikes.
Higher interest rates tend to have a negative effect on the price of stocks, as they compete with returns on the likes of bonds, and on corporate earnings potential.
In the interview, the economist pointed to the action in the stock markets on Thursday.
"We came back strongly and impressively from the inflation print because we had confidence in corporate earnings and we had the behavioral conditioning," he said.
"Then came the comments, which suggest a policy mistake that would lower economic growth and hurt earnings, and that's why we've come down again."
On Thursday, the 10-Year US Treasury yield rose to hit 2% for the first time since August 2019, and the market is now pricing in up to six Fed interest-rate hikes this year.
El-Erian also said Fed policymakers are way behind in the understanding of inflation and will have to regain credibility on this front.
He pointed to how their delay in tackling inflation means they are now being forced to move quickly, describing it as the "one thing we all wanted them to avoid."
"We didn't want them to be in a lose-lose situation," El-Erian said. "And increasingly they're being forced into a corner of just lose-lose."