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Bloomberg headshot photo of bond expert and economist Mohamed El-Erian

Portfolio > Economy & Markets

El-Erian: Rally May Signal Investors Have Lowered Their Expectations

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What You Need to Know

  • The market has redefined 'pivot' from cutting interest rates to slowing increases, El-Erian suggested.
  • If the Fed does slow, it will be from concern over financial stability, not because inflation has turned around, he said.
  • An ex-Fed official said the Fed will keep rates high until inflation comes down closer to its 2% target.

The current U.S. stock market rally may signal that investors have redefined what it would mean for the Federal Reserve to “pivot” when it comes to raising interest rates, essentially lowering their expectations, economist Mohamed El-Erian suggested Monday.

“I think what’s happening to our market, and it’s wonderful to have the best week since June, it’s wonderful to see the rally continue, is that we’ve redefined what a pivot is,” the Allianz chief economic advisor said on CNBC.

“We’ve redefined it from meaning lower rates, to pausing, to slowing. And if you redefine that, then you will have a liquidity effect, and that’s what we’re getting. We’re getting a liquidity effect rather than a fundamental effect,” he explained.

“And there’s reason for that because there’s significant value in certain parts of the market, so yes, you just need a catalyst,” El-Erian added.

If the Fed does slow rate hikes soon, it will be out of concern over financial stability, not because inflation has turned around, as the Consumer Price Index has continued to rise, he said.

“There’s concern that this front-loading of rate hikes, and it’s massively front-loaded, will break something in the financial system,” El-Erian said.

“If they stop it from getting worse and if this doesn’t harm us (and lead to stagflation), it will be good,” he added. “This is a trilemma. It’s not just growth versus inflation. It’s growth, inflation, financial stability. And somehow the Fed has to find its way through this. As does the (European Central Bank), as does the Bank of England.”

El-Erian cited comments that former Fed vice chairman Roger Ferguson made earlier Monday on CNBC suggesting inflation is running too high for the central bank and predicting policymakers will keep interest rates high for a long time.

Ferguson predicted the Fed would raise interest rates another 75 basis points at its Nov. 2 meeting and another 50 to 75 basis points in December, then make one or two more hikes in early 2023.

The market was wrong to “get off to the races” and once the Fed finishes raising interest rates, “it’s also going to stay there for a very long time until inflation is conquered, so I think the market is misreading the Fed’s intentions even if the Fed does slow down a little bit in terms of the pace at which it’s raising rates,” Ferguson said.

The pivot may be back on the table in investors’ minds, “but I think they’re losing track of the big picture, which is inflation is still running far too high for the Fed’s comfort and they’re going to use their tools, primarily interest rates, to get inflation much closer to the 2% target,” Ferguson added.

If he were at the Fed now, “I’d be scratching my a head a little bit as to why it is so hard to keep equity markets understanding the intention and do we have to make stronger speeches as well as take stronger actions,” the former Fed official said.


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