With Friday’s surprisingly disappointing jobs report adding to the confusion about America’s economic prospects, Business Insider reached out to Mohamed El-Erian for his views – not just on the economy but also on how the Federal Reserve is likely to react. Here is his response.
Yes, it is a rather confusing time for analysts of the US economy, and understandably so on account of both domestic and international factors.
Internally, the data have been mixed with an evolving bias to a weaker economy. This was highlighted in Friday’s employment report. In addition to a March job creation number that fell well short of expectations, the prior two months were revised down.
Abroad, the US faces notable headwinds on account of both demand and prices. Economic activity, and therefore demand for US exports, has moderated in China and remains sluggish in Europe and Japan.
The collapse of international prices for oil has hit hard an influential US sector. And the recent sharp appreciation of the US dollar has made it harder for certain US companies to compete abroad (and, in home markets, to outpace imports).
Having said all this, it is too early to call for a highly disappointing US year in terms of growth, jobs and wages.
The economy continues to heal from the shock of the global financial crisis and prior mal-investments in a wrong growth model. There are some exciting innovations that are in the process of “going macro” – that is transitioning from being influential at the company and sector levels to beneficially impacting the whole economy. Companies still have lots of cash on their balance sheets whose deployment on productive uses would make a significant economic impact. And even Friday’s disappointing jobs report had an important silver lining – the modest pickup in wage growth.
So what does all this mean for Federal Reserve policy?
If the economy were its only focus, the Fed would be looking at a rate hike as early as June despite the mixed data. The reasons for this include the impressive cumulative amount of job creation in the last 18 months, the concurrent sharp fall in the unemployment rate to close to what it deems as the NAIRU (the non-accelerating inflation rate of unemployment), the substantial financial healing of a significant parts of corporate and household America, diminishing concerns about price deflation, and lingering worries about the potential for resource mis-allocations that could result from the prolonged pursuit of its experimental monetary policy.
But the economy is not the only issue on the central bankers’ balance sheet.
Having used the financial asset markets as the main transmission mechanism to pursue its economic objectives, the Fed is worried that any misstep on its part would cause disorderly price movements and thus undermine economic dynamism. Indeed, memories of the May-June 2013 “Taper Tantrum” are still fresh in the minds of some central bankers, as are more recent episodes (albeit short) of market malfunctioning and sudden liquidity stress.
Where does all this leave the Fed?
Based on economic developments to date and what I expect will transpire in the next few months, look for the Fed to:
- Hike by and, most likely at its September policy meeting;
- Accompany this with stepped up communication that stresses the very gradual nature of subsequent rate hikes;
- Signal that the “terminal rate” will be below the historical average of some 4%;
- Iterate, and re-iterate several times that it will be highly responsive to both domestic and international data; and, as such,
- Stress that nothing is pre-determined about the timing, nature and magnitude of its future policy steps.
Mohamed A. El-Erian is the former CEO/co-CIO of PIMCO. He is Chief Economic Advisor at Allianz and member of its International Executive Committee, Chair of President Obama’s Global Development Council and author of the NYT/WSJ bestseller “When Markets Collide.”
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