Allianz chief economic adviser Mohamed El-Erian says the Fed miscalculates when it comes to inflation, and that the central bank’s inflation target from 2% to 3% may be the only way out. What does this exchange mean for gold and Bitcoin (BTC)?
Mohamed El-Erian: Fed is late
The Federal Reserve has waited too long to respond to problematic price pressures. Mohamed El-Erian, chief economic adviser to Allianz, said on Monday:
There will be no easy way out and it will be incredibly controversial. But that’s what you get when you wait too long to understand what inflation is and take action. We should have started QT (quantitative tightening) last year. We didn’t. We suffer the consequences of the Fed being so late.
How does it affect the performance of Gold and Bitcoin?
The Economist states that this means for the gold and crypto markets, “In a world like this, both go higher.” Gold is a well-known inflation hedge and is up 6.5% to date. Earlier in the week, the precious metal has risen nearly 9% since January after prices briefly surpassed the $2,000 mark. At the time of this writing, June Comex gold futures were down 1.78% on the day at $1,951.10.
Many Bitcoin advocates also argue that the world’s largest cryptocurrency is good inflation protection. But so far, Bitcoin has fallen 10.4% to date, and the entire crypto space largely reflects the performance of assets at risk, particularly US tech stocks. Bitcoin was last trading at $41,322, up 1.4% on the day.
The concern for crypto people is that this drop comes at a time when gold is rising and reaching almost $2,000. According to El-Erian, the big argument for crypto is that it is diversifying and attractive in times of inflation. However, the economist highlights the following:
But crypto, unlike gold, has benefited tremendously from all liquidity injections. So what you get in crypto is this conflict between acknowledging that liquidity is leaving the system as a whole and attractiveness as a diversifier.
What can the Fed do in the face of rising inflation?
Expectations are high that the Fed will tighten aggressively to control inflation, which is at a 41-year high. As we enter the May FOMC meeting, the market is pricing in a 91% chance for a 50 basis point rate hike, according to the CME FedWatch Tool.
The hawkish outlook comes with growing fears that the central bank will slow the economy too far with excessive rate hikes. That’s why the new inflation target gives the Fed extra room to maneuver, according to El-Erian. The Economist makes the following assessment:
What will force them to change their goals is the realization that by being so late they will not be able to reach that goal and their credibility is under threat. They will also worry that by pressing too hard they could push this economy not only into a short-term recession, but into a longer-term recession as well.
After underestimating the temporary nature of inflation and the impact of supply chain problems, the Fed has increased the rate from 1981 to 8.5% year-on-year in the US. It has been struggling with inflation, which has been at its highest pace since then. El-Erian adds that inflation is not about to peak either, commenting:
There is another inflationary impulse in the system. This comes from a very tight labor market. We cannot make an explanation above inflation, especially core inflation.
At its March meeting, the Fed started to react by raising interest rates by a quarter point for the first time since 2018. Speaking to reporters after the interest rate decision, Jerome Powell noted that the US central bank predicts six more rate hikes in 2022 and that the economy can “cope” with tighter monetary policy. Also speaking at the National Association for Business Economics conference in March, Powell said inflation was “too high” and it was time to act.
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