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El. Erian: Feds Will Wait; Buy Commodities
Aspire | 03 September 2015
By: Chen Xushuang
Articles (26) Profile

In Bloomberg’s live chat for readers on Aug 28, chief economic adviser at Allianz SE Mohamed El-Erian answered questions that investors are eager to know. Read here for the full article, and below are the main points extracted. Outlook for investors (based on El-Erian’s views): Reluctant Fed rate hike, possible volatility, and outflows pave a bumpy road for emerging market assets.

The Fed will Wait to Avoid Instability

Considering that “the Fed wishes to avoid excessive financial volatility and market instability”, El-Erian opined that a September Fed interest rate hike would have to wait. He also mentioned that for the last few years, the Fed’s major policy bet has been to “repress volatility in order to bolster asset prices as a way of encouraging household consumption and corporate investment”.

Thus he believed that even though the US continues to heal and economically out-perform others amidst time of global economic weakness, this may not be enough to reassure the Fed of a rate hike.

PROBABILITIES OF FED RATE MOVES/ BLOOMBERG

El-Erian even labeled the rate hike as the “loosest tightening” in the modern history of the Fed, and expected its destination to be a policy rate below historical averages. He also stated that the process will be much more data dependent and likely to involve stop-go characteristics.

OFFICIAL FOMC RATE FORECASTS/ BLOOMBERG

Underlying Causes of Volatility Still Present

The markets may have calmed down on the back of Chinese policy actions, but El-Erian still sees underlying causes of volatility present. He said that these include the challenging quest for high and sustained economic growth, overreliance on central banks and financial asset prices that are still decoupled from fundamentals.

As such, there are still many economic and policy handoffs that need to materialise, amidst a political environment that is far from conducive. In addition, with the change in market liquidity whereby the size of the intermediation function relative to end user demand is reduced, the general outlook points towards more bouts of volatility.

El-Erian also mentioned that outflows out of emerging markets in the past week were resulted by volatile losses experienced by the asset class, and this also reflects the difficulties that the asset class continues to face in establishing a large and secure enough base of “dedicated investors”. Thus, El-Erian sees a bumpy road ahead for emerging market assets.

Fed Tightening While China is Slowing?

The risk for Fed tightening has certainly grown, according to El-Erian. The bad news is that “virtually every systemically important emerging economy is slowing down”, and thus the US economy finds itself as “the only meaningful engine of global growth”.

However, he said that the good news is that there is ample private-sector cash on the sideline willing to engage, and the key is to evolve into a more enabling political process.

Decoupling—Can the US Grow with the Emerging World Slowing Down?

In terms of relative decoupling, El-Erian thinks that the US can continue to grow while the rest of the world is slowing. But in terms of absolute decoupling, he said that the US will find it very hard to achieve the “escape velocity” needed for economic liftoff, and that it will continue to face downward pressure on its future growth potential.

What Techniques Can the Fed Use to Address Another Downturn?

Despite the fact that the world has already used quite a bit of its crisis management ammo, and that people are growing increasingly doubtful towards the future effectiveness of unconventional policies, El-Erian sees some positive elements as well. Looking beyond central banks, he thinks that there are still quite a few underutilised policy tools.

The most important ones will have to do will unleashing existing growth capabilities and better matching the will and wallet to spend. He also expects their effectiveness to be turbocharged by the engagement of the significant amount of cash now sitting on the sidelines, as well as transformational innovations.

Investors’ Takeaway

Despite possible rate hikes, it was mentioned in an earlier article by S&P experts that the hike would be minimal and acceleration would be gradual. Inevitably, many investors holding commodity stocks would be afraid that even a slight interest rate hike would have a great impact.

However, the experts think that commodities are already bottoming out, which might actually indicate a rebound soon. Furthermore, now that El. Erian mentioned that the Feds would most probably wait out, commodity stocks can prove to perform in the short term.

As a Communications Studies graduate specialising in journalism, Xushuang is keen to observe and explore issues that readers want to know more about, and to deliver quality content through engaging writing.

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