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El-Erian, Crescenzi Explain Why Investors Are Betting on the Fed

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Investors are in a gambling mood when it comes to the Federal Reserve.

That’s the conclusion one could reach after listening to veteran strategists, Bloomberg Opinion columnist Mohamed El-Erian and Pacific Investment Management Co.’s Anthony Crescenzi, explain market rallies in a week where the Fed raised overnight lending rates and the U.S. economy signaled a recession.

The S&P 500 is on track for its best month since November 2020 and the Bloomberg Treasury Index could close July with the biggest gains since the start of the pandemic.

Bond market investors are “entertaining the idea that the Fed can’t go far” in raising rates further to stem the fastest inflation in decades, Crescenzi, a portfolio manager and member of the investment committee at Pimco, told Bloomberg Television’s Surveillance on Friday.

“For the equity market, some of it reflects the optimism that might be building not just toward the idea that the policy rate may not have to go as high as some feared, but that the economy is stronger, at least its foundation is stronger than many thought,” Crescenzi added.

When the Fed raised the fed funds rate 75 basis points on Wednesday, Chairman Jerome Powell said, “While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data.” This raised speculation that if data show the economy worsening, the Fed will make a so-called pivot away from increasing rates.

On cue, the Commerce Department the next day said the economy contracted for a second straight quarter, shrinking at a 0.9% annualized rate after a 1.6% decline in the first three months of the year. Some might call that a recession, though financial markets debate whether we’re quite there yet.

Markets may be seizing on Powell’s unscripted remark at his press conference that fed fund rates “are at neutral,” El-Erian, chairman of Gramercy Funds and former head of Pimco, told Bloomberg TV’s The Open. “If you believe we are at neutral, the scope for a soft landing of the economy goes up significantly and that’s the reason why you will get the pivot. My own instinct is that the Zip code for neutral is above where we are now.”

The central bank, after raising rates four times this year, is persuading investors that its future decisions will work out, according to Crescenzi.

“The Fed has regained control of the inflation narrative. The markets are benefiting from the Fed’s tough love,” the Pimco manager said. The bond market is showing “confidence in the Fed,” he said.

El-Erian, who said more than a year ago that the Fed was behind the curve in battling inflation, is wary.

“The market is looking for a pivot at a time when the only reason you would get it is the economy collapses,” El-Erian, said. “And if that happens, equities may not be able to withstand that. This shows you how much uncertainty there is. I think the market has come to the conclusion what it wants before the Fed gets there.”

(Photo of Mohamed El-Erian by Wei Leng Tay/Bloomberg)

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