Photo: Bloomberg TV
Mohamed El-Erian, CEO of PIMCO, has penned a blistering op-ed for the Financial Times on the dangers of highly accommodative monetary policy – or as he refers to it, the ‘central bank put.’The central point of his argument lies in the notion that the Fed’s easy-money policies have divorced prices from market fundamentals. As a result, investors are not choosing an asset on the basis of fundamental analysis, but rather on its value relative to another asset as part of the search for yield. The higher appetite for risk has been spurred by expectations of persisting ultra-low interest rates and continued quantitative easing by the Fed.
As central bank balance sheets swell, El-Erian believes that investors will soon refuse to accept investment vehicles, such as high yield corporate bonds, equities, and highly leveraged products, whose valuation is often indirectly influenced by the Fed’s asset purchases, and to a lesser extent, its forward policy guidance.
The prices of these asset classes are divorced from their fundamentals, he explains, and “With the weaker central bank impact, prices need to have greater consistency with the realities of balance sheets and income statements.”
Here’s what El-Erian says will happen if and when the punch bowl of monetary easing runs dry, is removed, or investors decide to stop sipping from it:
…investors should expect security and sector selections to get repeatedly overwhelmed by macro correlations. Since a growing number of asset classes are now exposed in a material fashion to the belief that central banks will deliver macroeconomic as well as market outcomes, investors have assumed considerable macro-driven correlations across their holdings. Moreover, with seemingly endless liquidity injections, the scaling of such exposure can easily disconnect from the extent to which prices deviate from fundamentals.
In other words, he predicts looming corrections in asset classes that have not been directly influenced by monetary accommodation and asset purchases, but have nonetheless been benefitted indirectly from central bank easing and relative cross-asset valuation.
Read the whole op-ed at FT.com.