On Wednesday, the Federal Reserve decided to hold interest rates at a 23-year high, coinciding with calming inflation data from May's Consumer Price Index (CPI) out that morning. The May Producer Price Index (PPI) saw wholesale prices drop by 0.2% month-over-month. Fed Chair Jerome Powell stated he is aware of the economic ripple effects of holding rates too high for too long will have, while also maintaining caution over rushing into a rate hiking cycle.

Allianz Chief Economic Advisor Mohamed El-Erian tells Yahoo Finance's Seana Smith, Madison Mills, and Julie Hyman he believes there is a 35% chance the Fed may start cutting rates too late:

Already, the cushions that small businesses have and poor households have have already been eroded. Pandemic savings have gone, debt levels are high, delinquencies are going up. So I worry that if they carry through on what is in the SEP {Summary of Economic Projections dot plot], that will be too late," El-Erian outlines. "Now, the good news... is I strongly believe that had they had the CPI data a couple of days earlier and had they had today's PPI data, we would have gotten a different SEP."

El-Erian finds equity markets (^DJI, ^IXIC, ^GSPC) are totally ignoring the Fed, taking into account the massive run-ups the S&P 500 and Nasdaq Composite have seen over the past week. He also weighs in on headlining trends in the US labor market and Americans' income.

For more expert insight and the latest market action, click here to watch this full episode of Catalysts.

This post was written by Luke Carberry Mogan.

Catch up on Yahoo Finance's coverage and reporting of the Fed's interest rate decision from Wednesday, and the central bank's policy outlook for 2024:

How to read the Fed's updated dot plot

The Fed isn't really taking 2 rate cuts off the table

Fed 'dot plot' suggests central bank will cut interest rates one time in 2024, down from 3 cuts in March

Fed trying not to get 'stuck' in inflation: Evercore ISI's Guha

Fed 'dot plot' has 'enormous' utility: Fmr. Dallas Fed pres.

Fed's unanimity, 'lack of debate' is 'troubling': Economist

Fed's December rate cut would come 'too late': Mohamed El-Erian

A September rate cut is 'too close' to election: Strategist

Inflation was the day's real market mover, not Fed policy

Video Transcript

But first we have to talk about today is a big story and that is inflation and the fed producer prices see their biggest decline since October.

This coming after consumer prices cool more than economists had expected in the latest report yesterday on Wednesday.

Still the fed remaining cautious only forecasting one rate cut this year.

When asked, asked about the risks of waiting to cut rates.

Here is what FJ Powell had to say.

We understand that if we wait too long, that could come at the cost of economic activity, of employment of the expansion, we understand that if we move too, too quickly, we could end up undoing a lot of the good that we've done and have to then start over and it could be very disruptive.

So we, we're, we're extremely aware of both, both of those risks joining us.

Now, we want to bring in Mohammed, El Erian.

He is Allianz Chief economic Adviser as well as our very own Julie Hyman here joining the conversation as well.

Mohammed.

It's great to see you.

Thanks so much for taking the time to join us.

I I wanna start with what we just heard that thought that we just played, that we just played here from Fed chair, Jay Powell.

He's saying that the fed is acutely aware of the risk here to both sides saying that the fed once again, reiterating remaining data dependent.

I'm curious though, that downside risk of the fed waiting too long.

What exactly do you think that could look like?

And the odds of that actually happening at this point?

So I think Chad Powell is correct in pointing out that there are two tails to the soft landing.

The soft landing is what he's targeting.

Um, but there are risks on both sides.

I think what he misses is the balance of that risk that the balance unfortunately is in favor of them being too late and the economy is slowing more than it should and small businesses and low income household being hit particularly hard.

You ask, what is that probability?

I put it at 35%.

There's a 35% probability that they may end up too late.

Now, the good news is not about 50 but it's a pretty fat tail that the fed should be very, very attentive to, uh Mohammed.

It's Julie here.

It's great to see you.

So at this point, when is too late, do we have a decent idea of the timing of, of when the fed should begin cutting and when it actually is likely to begin cutting?

So, in my opinion, too late, is what is reflected in yesterday's SEP or do plot, which is the possibility of one hike.

And let's remember, four people said no hikes.

And if this is the normal fed hiking cycle, that one hike would come in December, so that in my opinion, would be too late.

By that time, the lag effects of what was a significant increase in rates would be biting even more already, the cushions that small businesses have and household poor households have have already been eroded.

You know, pandemic savings have gone debt levels are high delinquencies are going up.

So I worry that if they carry through on what is in the SEP, that will be too late.

Now, the good news Julie is, I strongly believe that had, they had the CP I data a couple of days earlier and had they had today's PP data, we would have gotten a different sep. Um And while you're mentioning the SEP as well, you say if they carry through, well, we know that, you know, the S and P, we sort of take it as a very loose guide.

I think Powell himself has sort of uh eluded in that direction.

So, I mean, how should we as investors read it?

Well, we should read it as the markets are reading it today and yesterday, ignore it.

That's exactly what the market did.

If the market had taken it seriously, it would have seen first two cuts go to one.

It would have three cuts go to one.

It would have seen four people expect no cuts.

It would have seen a higher inflation forecast for this year and it would have seen a high estimate for neutral rate.

That's a real hawkish tilt.

But the market for the reasons you've cited are saying, well, you know what, I'm going to ignore that and that's why we're seeing the rally in both fixed income and inequities.

And I think that's the right thing to do.

You know, that's part of me that thinks that the sep is excessive transparency, excessive communication.

Well, they are excessively communicating Mohammed but not always the same message.

We heard a lot of dissent and we saw a lot of dissent in that job plot in particular.

So I'm curious from your perspective, if you think the Fed has lost the plot a little bit and given the amount of dissent amongst the voting members, is that potentially more harmful than helpful at this point?

You know, matter, lots of people think that.

And if you look at the questioning yesterday, the chair was really pressed on.

Wait a minute.

This doesn't make sense.

I think what you're getting is the consequences of what I call excessive data dependency.

You know, the Fed made a very big mistake.

In 2021.

They took a forward looking view of inflation.

They said inflation was transitory.

They held on to that belief for too long.

And as a result, we had a massive hiking cycle including four consecutive hikes of 75 basis points.

So I think they were so shaken by that mistake that they became just backward looking.

And this is an excessively data dependent fit when data itself is very noisy, which it has been and the market has reacted up and down, up and down in terms of yields to that market to that data, that volatile data, they end up coming across as confused.

What the fed desperately needs is to have the courage to take a forward looking view of what the economy is going to do and stick to that view and anchor the markets better.

I think Nick tires in the Wall Street journal called it Inflation ptsd in his discussion of the Fed and its mindset right now.

Um Mohammed, the last time we talked, you said, you know, when you're looking at all this backward looking data, one of the places you go to find sort of more forward looking data is actually company conference calls, earnings calls.

And I'm curious since we last spoke, what you are gleaning from those calls, what what I'm leaning is what the forward looking indicators are telling us as opposed to historical data is that demand is weakening.

You hear over and over again uh in the different corporate calls, you see it in sentiment.

And that's why I think that the risks that we started this interview with uh with the fed share flip is asymmetrical Julie.

I think there's a much bigger risk that we weaken faster than the FED expects than the other risk that inflation ends up much higher than the fed expects.

Mohammed.

Are, are, are you concerned about some of the weakness that we are seeing within the labor market?

And we talk about how maybe much more of a focus the fed should or maybe will be placing on some of the softness that we have been seeing.

What are your thoughts there?

And just the risk that this ultimately poses here obviously to the broader economy.

Now, I worry about it and I worry about it, Shona because there are no buffers anymore.

If you are a low income household, if you are a small business, you're highly reliant on whatever income you're generating, you no longer have the buffer or the access to the debt markets that you had before.

So that if something goes wrong in the case of household, it would be if something goes wrong in the labor market, then it will not be linear.

This economy will not weaken in a linear fashion.

It risks weakening in an accelerated fashion.

You know, I look back at, at different hiking cycles and followed by cuts and the one that soft landed in my lifetime and I'm old is 1995 and there the fed cut pretty early.

Um All the others have ended up in bad news because the fed, the fed tends to be late.

This data dependent fed because it's so backwardly looking is so reactive in its, in its reaction function that it risks being really late.

I want to end by asking you about something we talk about a lot with regards to those company earnings calls that Julie mentioned, which is the A I boom.

And there's this idea that A I is going to drive so much corporate efficiency moving forward.

How much do you factor that idea into your overall macro outlook?

I certainly factor it when I go beyond one year to the three year and the five year, you know, the what A I can do to productivity is gets translated into bigger but not hotter.

It will allow us to grow more faster, but it will not mean that we will be, there will be a speed limit in terms of inflation, the speed limit will be better than it is now on there.

Now, there are labor consequences.

There's all sorts of other things we have to pay attention to, but it is truly a productivity enhancing tool that will move the supply side in a favorable way and that will allow us to grow better over the long term.

All right mom, and we're gonna have to leave it there.

Thank you so much for joining us.

That was Mohammed El Erian Allan's Chief economic Advisor and thanks to our own Julie Hyman for bringing us this interview as well.