The Fed has prolonged an unhealthy co-dependence with markets and it threatens financial stability, Mohamed El-Erian says

• Mohamed El-Erian said the Fed has an unhealthy co-dependence with markets.
• It threatens financial stability and the economic well-being of current and future generations, he added.
• Fed Chair Jerome Powell's remarks last week fueled rate-cut hopes, triggering a rally across assets.

The Federal Reserve and markets have an unhealthy co-dependence that threatens financial stability, according to economist Mohamed El-Erian.

In a Bloomberg column published Thursday, he blasted Fed Chair Jerome Powell for his remarks at last week's policy meeting that hinted at coming interest rate cuts.

"Central banks' deterministic influence on asset prices was to give way to other factors, particularly the outlook for economic growth, the smoothness of the last mile of the inflation fight, and the availability of funds to readily absorb the step-up in debt issuance due to large deficits and higher borrowing costs," El-Erian said.

Yet in El-Erian's view, that hasn't happened.

The Fed should have stepped out of the limelight as policy neared peak restrictiveness, he argued. But instead it cemented its leading role in the narrative of markets by spurring an early Santa Claus rally and raising expectations for rate cuts.

With little success, other central bankers have chimed in, trying to walk back what markets saw as a sign of an imminent Fed pivot, El-Erian added.

In fact, just two days after the FOMC meeting, New York Fed President John Williams told CNBC that "we aren't really talking about rate cuts right now."

El-Erian also said Powell fueled bets that the Fed will cut rates faster than the European Central Bank would, even though the US has a stronger growth outlook than the eurozone does.

Markets don't expect any changes to interest rates at the next FOMC meeting, scheduled for January 31. However, investors are widely expecting a reduction at the following meeting in March with odds at 71% for a 25-basis-point cut.

"The prolongation, yet again, of an unhealthy co-dependency between a Fed, which is inclined to be dovish and overly talkative, and markets, which too often drift into being single-issue focused, risks evolving in a manner that goes beyond abnormal," El-Erian warned. "It increasingly threatens the economic well-being of current and future generations, as well as overall financial stability."