The Fed will deliver a 'big shock' to markets if it tightens monetary policy too slowly, says Mohamed El-Erian

• The Fed moving too slowly in tightening monetary policy would jolt financial markets, said economist Mohamed El-Erian.
• While not a baseline case, the Fed risks slamming the economy back into recession, he said.

The Federal Reserve will start winding down stimulus measures it enacted when responding to the COVID pandemic last year, but tightening monetary policy at a slow pace could send investors fleeing out of stocks, renowned economist Mohamed El-Erian said Monday.

"When you get a big shock in the marketplace, you get an increase in risk aversion...So what would be this big shock that we have to avoid? A policy mistake," El-Erian said during an interview on CNBC.

"For example, the Fed being too slow and then having to slam on the brakes and sending the economy into recession. That's not a baseline but that's a risk. That's the sort of thing that can change mindsets from relative to absolute [about equities]. Hopefully, we can avoid that."

The Fed last week said it would begin later in November lowering the amount of bonds and mortgage-backed securities it purchases each month from the current pace of at least $120 billion.

The move suggests the Fed will look to tamp down on inflation levels after focusing on fostering an economic recovery. Investors largely expect the Fed to begin raising interest rates from near zero as early as mid-2022.

But a few months ago, El-Erian said the US central bank should already have been tapering asset purchases as inflation has been persistently high. Economists have pointed to a number of factors including supply-chain issues plaguing numerous industries as reasons for consumer and wholesale inflation readings surging to and sticking around multi-year highs.

"[We] don't have a historical experience where the Fed has been late in tightening and hasn't sent us into recession," El-Erian warned on Monday, noting a recession would hit earnings, the key driver of stock prices.

The S&P 500 index on Monday closed at a new record high, bringing its gain this year up to about 25%.