PIMCO CEO Mohamed El-Erian said Monday that although the G-8 Summit would bring powerful world leaders this week to Northern Ireland, all eyes in market and economic circles would be on the Federal Reserve’s meeting Tuesday and Wednesday because central banks are better these days at setting policy than politicians.
“When it comes to economic issues, this Summit will again be big on proclamation but risks being largely ineffectual when it comes to immediate measures that make a difference on the ground,” wrote El-Erian (left) in a comment published by Fortune at CNNMoney.com. “Not so for the Federal Reserve, where even a bland outcome can make a difference.”
The Fed and other Western central banks have been at the forefront of efforts to revive economic growth, create jobs and maintain financial stability, according to El-Erian, who serves as PIMCO’s co-chief investment officer alongside Bill Gross.
“Lacking the support of other policymaking entities, they have courageously taken on important policy objectives with imperfect and highly experimental tools,” El-Erian wrote. “As such, there is genuine uncertainty today about the future evolution of the cost-benefit equation, and what this means both for the willingness of central bankers to stay the course and for their current and future effectiveness.”
Nervousness About Rising Interest Rates
El-Erian’s comments come as interest rates have recently started to rise—even though inflation is in check and the U.S. unemployment rate stubbornly remains above 7%. Yet the benchmark 10-year U.S. Treasury note rose to as high as 2.29% last week (its highest level since April 2012), and mortgage rates look to be rising toward the 4% mark.
Why? Because investors are nervous, and they keep waiting for central banks such as the Fed to turn off the easy-money spigot. As a result, investors are reducing their exposure to bonds and sending rates higher, which has the effect of pushing bond prices down.
“The ongoing bond sell-off has offered investors few places to hide,” wrote Anthony Valeri, fixed-income market strategist for LPL Financial, in a fixed income call note on June 11. “Most bond sectors have suffered price declines, in some cases worse than Treasuries, in what has been a general rebuke of bonds in response to uncertainty about the timing of Fed tapering.”
Buzzword du Jour: ‘Tapering’
That word—“tapering”—has become the buzzword du jour as market players now watch for any sign that the Fed is shutting down its quantitative easing (QE) program, which has supported historically low interest rates in response to the financial crisis of 2008.
For example, Michael Hanson, senior U.S. economist for Bank of America-Merrill Lynch, wrote on Monday that he expects the Federal Open Market Committee (FOMC) at this week’s meeting “to leave the door open to tapering” before the end of 2013.
“The markets could interpret a neutral-sounding directive as a tacit endorsement of the repricing of Fed policy,” Hanson added. “Our base case remains that persistently low inflation and slower growth in Q2 and Q3 will delay any cut in the Fed's monthly QE3 purchase pace until 2014.”
Similarly, El-Erian believes that market watchers will look on Wednesday for three specific issues: whether the FOMC still intends to taper the exceptional support it provides markets and the economy; how concerned officials are about the cost and risks of their policy experimentation; and whether the negative global side effects are registering inside the Fed’s policy deliberating committee.
“I suspect that the Fed will attempt to walk back on its tapering narrative, recognize but downplay the collateral damage and unintended consequences of its experimental policy stance, and convey little about negative global externalities,” he predicted.
At the same time, El-Erian suspects that the Fed will (in a dignified manner) beg the world’s politicians to act decisively on basic policy issues such as jobs and economic growth—and he also suspects that it won’t meet with much luck due to political constraints.
“Whether in the official statement or in the remarks that follow, officials will again call for support from other policymaking entities,” he wrote. “And the great irony will be that this call will follow a disappointing communique from the G-8…. Until this basic imbalance is corrected, global growth and employment will fall short of what is both required and possible; and markets will lack the sustained underpinnings of strong fundamentals.”
Read PIMCO’s Gross: Fed in a Corner, Will ‘Taper’ by Year’s End at AdvisorOne.