Change of leadership means interest rate cuts? Allianz chief pours cold water: FOMC is already fragmented, new officials find it hard to take control

Allianz Chief Economic Advisor Mohamed El-Erian wrote today that although the market generally expects the new Federal Reserve Chairman nominated by Trump to quickly push for interest rate cuts, this short-term market reaction may not be as severe as anticipated. The real challenge facing the new chairman is how to reshape the long-term credibility of the Federal Reserve through deep reforms.

With the "extremely dovish" Hassett being "designated" as the Federal Reserve Chairman, the market bets that if he is actually nominated, it may trigger a decline in short-term Treasury yields, a weakening of the dollar, and an increase in inflation expectations, thereby widening the gap between long and short-term interest rates.

However, in a commentary published on the 9th in the Financial Times, El-Erian poured cold water on this. He warned that even if the nomination is confirmed, the aforementioned market trends are unlikely to be sustained. This is not only because the prediction market has already priced in these expectations, but also because the Federal Open Market Committee (FOMC) is increasingly divided and lacks a unified strategic vision. The new chairman will not only find it difficult to establish authority in the short term but may also face resistance from current committee members who want to avoid being seen as yielding to political pressure, making it challenging for a single nominee to quickly change the policy direction.

He emphasized that compared to the market's excessive focus on the short-term prospects of interest rate cuts, the long-term institutional reforms that the next chairman will implement at this globally significant central bank are the key factors that will have a more profound impact. During this period of structural change, the Federal Reserve urgently needs to move away from a decision-making model that relies on outdated data and recalibrate its analytical framework and governance culture.

Priced Expectations and Limited Power

Regarding the market's optimistic expectation that a change in leadership will lead to interest rate cuts, El-Erian believes this assumption is built on a fragile foundation. First, the market has a high capacity for efficient pricing. In the prediction market, Hassett currently leads by a significant margin, which means that the likelihood of his election and his potential policy inclinations have already been absorbed by investors, and the marginal impact at the time of the official announcement may be limited.

More critically, any new chairman will need time to establish authority within this vast bureaucratic institution. El-Erian pointed out that the current FOMC has become more divided, lacking a unified strategic vision due to conflicting signals between the dual mandates of "maximum employment" and "price stability," as well as concerns about financial stability.

In addition, the new leader will also need to deal with a highly sensitive committee. Current members are extremely wary of any accusations of yielding to political pressure, and this mindset may lead them to resist, out of a desire to maintain independence, even when faced with a new chairman determined to change the status quo.

"Rearview Mirror" Decision-Making and Trust Deficit

The article further analyzes that the next chairman will inherit a committee that is overly reliant on "rearview mirror" data. This path dependence on past data makes it difficult for the Federal Reserve to accurately diagnose complex issues such as labor market weakness. In recent years, the Federal Reserve has repeatedly made mistakes in analysis, forecasting, policy implementation, and communication, especially the recent dramatic fluctuations in expectations for this week's policy meeting, which exposed the lack of anchoring in its policy framework and the failure of forward guidance The damage to institutional credibility is further exacerbated by governance issues. Although some allegations of financial misconduct against officials have not been proven illegal, this has intensified public distrust. According to a Gallup poll conducted in October this year, only 9% of Americans believe that the Federal Reserve is performing "outstanding," far below the percentage who think its performance is "poor" (27%) or "average" (35%). This trust deficit makes the Federal Reserve increasingly vulnerable to political attacks from both the left and the right.

Beyond Rate Cuts: Urgent Structural Reforms Needed

El-Erian believes that all the shortlisted candidates seem acutely aware of the urgency for reform. The historical mission of the next chair should not be limited to rate cuts, but rather to implement a series of reforms aimed at enhancing the Federal Reserve's performance and safeguarding its independence.

This reform agenda is lengthy and specific: it includes adjusting the way inflation targets are set, modifying the "dot plot" mechanism that displays policymakers' interest rate expectations, and other communication practices. At the same time, the Federal Reserve needs to update its balance sheet management strategy, strengthen accountability, enhance compliance culture, and more broadly challenge internal "groupthink."

More importantly, the Federal Reserve's decision-making logic needs to shift from an obsession with demand-side management to a greater focus on supply-side developments. El-Erian emphasizes that the global economy is undergoing a significant structural transformation from the fragmentation of the global order to the rise of artificial intelligence, and the Federal Reserve's existing models based on historical data are no longer sufficient to address these changes. If the new chair can advance the Federal Reserve on these reform issues, their value will far exceed mere rate cuts, as this will restore the effectiveness and credibility of this key institution in guiding the economy through change