diff --git a/xds/src/main/java/io/grpc/xds/LookasideLb.java b/xds/src/main/java/io/grpc/xds/LookasideLb.java
index 7c1c0e4837..68c834f0f6 100644
--- a/xds/src/main/java/io/grpc/xds/LookasideLb.java
+++ b/xds/src/main/java/io/grpc/xds/LookasideLb.java
@@ -502,6 +502,7 @@ final class LookasideLb extends LoadBalancer {
     @Override
     public void onError(Status error) {
       channelLogger.log(ChannelLogLevel.ERROR, "EDS load balancer received an error: {0}",  error);
+      lookasideLbHelper.updateBalancingState(TRANSIENT_FAILURE, new ErrorPicker(error));
       endpointUpdateCallback.onError();
     }
   }
diff --git a/xds/src/main/java/io/grpc/xds/XdsLoadBalancer2.java b/xds/src/main/java/io/grpc/xds/XdsLoadBalancer2.java
index fdbfdf5149..564b085fdb 100644
--- a/xds/src/main/java/io/grpc/xds/XdsLoadBalancer2.java
+++ b/xds/src/main/java/io/grpc/xds/XdsLoadBalancer2.java
@@ -28,6 +28,7 @@ import io.grpc.Status;
 import io.grpc.SynchronizationContext.ScheduledHandle;
 import io.grpc.util.ForwardingLoadBalancerHelper;
 import io.grpc.xds.LookasideLb.EndpointUpdateCallback;
+import io.grpc.xds.XdsSubchannelPickers.ErrorPicker;
 import java.util.concurrent.TimeUnit;
 import javax.annotation.CheckForNull;
 import javax.annotation.Nullable;
@@ -118,6 +119,10 @@ final class XdsLoadBalancer2 extends LoadBalancer {
 
         @Override
         public void run() {
+          helper.updateBalancingState(
+              ConnectivityState.TRANSIENT_FAILURE,
+              new ErrorPicker(Status.UNAVAILABLE.withDescription(
+                  "Channel is not ready when timeout for entering fallback mode happens")));
           useFallbackPolicy();
         }
       }
diff --git a/xds/src/test/java/io/grpc/xds/LookasideLbTest.java b/xds/src/test/java/io/grpc/xds/LookasideLbTest.java
index fd907d341c..7baf2ce7a7 100644
--- a/xds/src/test/java/io/grpc/xds/LookasideLbTest.java
+++ b/xds/src/test/java/io/grpc/xds/LookasideLbTest.java
@@ -787,8 +787,11 @@ public class LookasideLbTest {
   public void verifyRpcErrorPropagation() {
     lookasideLb.handleResolvedAddresses(defaultResolvedAddress);
 
+    verify(helper, never()).updateBalancingState(
+        eq(TRANSIENT_FAILURE), any(SubchannelPicker.class));
     verify(edsUpdateCallback, never()).onError();
     serverResponseWriter.onError(new RuntimeException());
+    verify(helper).updateBalancingState(eq(TRANSIENT_FAILURE), any(SubchannelPicker.class));
     verify(edsUpdateCallback).onError();
   }
 
diff --git a/xds/src/test/java/io/grpc/xds/XdsLoadBalancer2Test.java b/xds/src/test/java/io/grpc/xds/XdsLoadBalancer2Test.java
index db8b82e2ff..694f5e5707 100644
--- a/xds/src/test/java/io/grpc/xds/XdsLoadBalancer2Test.java
+++ b/xds/src/test/java/io/grpc/xds/XdsLoadBalancer2Test.java
@@ -19,6 +19,9 @@ package io.grpc.xds;
 import static com.google.common.truth.Truth.assertThat;
 import static io.grpc.ConnectivityState.CONNECTING;
 import static io.grpc.ConnectivityState.READY;
+import static io.grpc.ConnectivityState.TRANSIENT_FAILURE;
+import static org.mockito.ArgumentMatchers.any;
+import static org.mockito.ArgumentMatchers.eq;
 import static org.mockito.ArgumentMatchers.same;
 import static org.mockito.Mockito.doReturn;
 import static org.mockito.Mockito.mock;
@@ -144,7 +147,9 @@ public class XdsLoadBalancer2Test {
     fakeClock.forwardTime(9, TimeUnit.SECONDS);
     edsUpdateCallback.onWorking();
     verifyNotInFallbackMode();
+
     fakeClock.forwardTime(1, TimeUnit.SECONDS);
+    verify(helper).updateBalancingState(eq(TRANSIENT_FAILURE), any(SubchannelPicker.class));
     verifyInFallbackMode();
 
     SubchannelPicker subchannelPicker = mock(SubchannelPicker.class);