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Don’t Wish for the Fed to Pause Rate Hikes in September

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Last week’s rising stock prices suggested that many investors are still wishing the Federal Reserve will step in to counter downward pressures on the market. Hopes for this “Fed put,” however, may be confusing the Fed’s willingness to act with its ability to do so.

Markets breathed a noticeable sigh of relief last week when Raphael Bostic, the president of the Atlanta Fed, opened the door to the possibility that the Fed might pause its rate hikes in September. Such a hiatus would be warranted not by the Fed regaining control of inflation but rather by concerns about the effects of continued tightening on the equity markets.

It’s premature for investors to hope that such an early pause would boost stocks.

Given persistent high inflation, the Fed is theoretically barred from easing financial conditions in the short term just to support the stock market. This constraint could be relaxed, however, in two ways — one good and one bad.

First, an already late Fed could theoretically succeed quickly in fighting inflation. That would require improvements on the supply side of the economy, due to the resolution of supply-chain bottlenecks and to higher growth in productivity. Such a scenario would also need labor force participation to increase, and have a mix of accumulated personal savings and targeted government support enable most households to navigate the transition period.

The bad way involves income-related problems amplifying the pressure that households face from rising prices. In this case, aggregate demand will fall throughout the economy, as reduced consumption discourages business investment and exports, and as a Fed playing catch-up miscalculates the effects of simultaneously hiking rates and contracting its balance sheet. Inflationary pressures would subside, but at a significant cost to Americans’ economic, social and financial well-being.

While we should hope for the former possibility and take steps to avoid the latter, it’s unrealistic to expect that either one will play out in the next three months. So it’s hard to come up with a convincing case at this stage for the Fed to pause rate increases in September after the widely anticipated 50-basis-point hikes on June 15 and July 27.

This doesn’t mean the Fed will not be tempted to pause in September. Considering how long last year the Fed stuck by its mischaracterization of inflation as transitory, it is not out of the question that the Fed could again do something that it shouldn’t.

One of the biggest policy threats to economic stability in the coming 18 months is that the Fed will end up in a go-stop-go cycle — that is, raise rates and then stop, only to be forced to start again. A first late and then flip-flopping Fed would condemn the US economy to a much longer period of painful stagflation and increase the risk of recession.

For years, the Fed has shown great willingness to step in to counter pressure on asset prices, and this willingness may well remain in place. But it is no longer a determining factor. What is in play now is ability. That ability will not be restored by September unless inflationary indicators drop sharply due to a consequential and highly damaging fall in economic activity. And that’s not something investors should wish for.

More From Bloomberg Opinion:

• Fed’s Mild Inflation Forecasts Need Explaining: Bill Dudley

• This Risk-On Rally Rests on Risky Foundations: John Authers

• Did US Consumer Spending Just Hit Its Peak?: Robert Burgess

(Corrects spelling of Raphael Bostic in the second paragraph.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. A former chief executive officer of Pimco, he is president of Queens’ College, Cambridge; chief economic adviser at Allianz SE; and chair of Gramercy Fund Management. He is author of “The Only Game in Town.”

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