The U.S. Federal Reserve is moving appropriately on the path to unwind asset purchases and normalize rates, while the European Central Bank (ECB) may be too hesitant, said Mohamed El-Erian, chief economic advisor at the Allianz Group.
The Fed, ECB and Bank of Japan (BOJ) need policymakers to step up to take action on structural reforms to be more effective, El-Erian told the Reuters Global Markets Forum in an interview on Friday.
Following are edited excerpts from the conversation:
Q: Are central banks taking the right route to unwind their asset purchases and normalize rates?
A: When it comes to taking the foot off the unconventional stimulus pedal, the Fed appears to be moving appropriately. The ECB may be showing a little too much hesitancy. Importantly, the two of them – as well as the Bank of Japan – need other policymakers, with tools better suited for the task at hand, to step up to the plate more forcefully – especially when it comes to pro-growth structural reforms, more balanced demand management, better cross-border policy coordination and, in some isolated cases, targeted debt reduction (e.g., Greece).
Otherwise, it will be challenging for the central banks to deliver a “beautiful normalization,” adopting a phrase from Bridgewater’s Ray Dalio. As you know, I have worried that the central banks have been “the only game in town” for too long already.
Q: Your thoughts on Fed’s balance sheet trimming? Certain sections of the market, for instance, believe balance sheet reduction should only start once the Fed funds rate is near 2 percent.
A: Yes, I agree. My own inclination would be to go some significant way in normalizing rates before initiating an active reduction in the Fed’s balance sheet. Remember, this is unchartered territory. There are several uncertainties, so it is extra important to sequence carefully and implement in a measured fashion.
Q: How many U.S. rate-hikes are you expecting in 2017?
A: I expect that, absent a major negative shock, there will be a total of three rate hikes in 2017 — so two more in the remainder of the year.
Q: What are your thoughts on the relationship between Trump and Chinese President Xi Jinping, which is proving to be much friendlier than expected given Trump’s campaign rhetoric, and what does that mean for markets or investments? [nL1N1I0067]
A: Yes, it looks like the two leaders had a good meeting in Washington, establishing a working relationship that appears to be deepening. This is very important as you are talking about the most important bilateral economic relationship in the world – between the largest economies.
As such, it has a notable influence on markets/investment. The economic and financial relationships between the U.S. and China are considerable and multifaceted. Indeed, given the current scale and scope of inter-connectedness, the most likely long-term outcomes are either win-win or lose-lose. And the dynamics involved could well be those of multiple equilibria. As such, the stakes are high for the global economy and markets.
Q: Do you think the deleveraging efforts in China are working?
A: The deleveraging process is proving to be a very gradual process. Fortunately, China has time and the pockets of excessive leverage are containable. But there will be the periodic stress, and it’s one that requires timely policy responses.
Q: What is your view on the dollar? Could it get a further boost from U.S. President Donald Trump’s policies?
A: A lot depends on policies. Specifically, the dollar would get a boost from the implementation of pro-growth measures that would also allow the Federal Reserve to normalize both interest rates and its balance sheet. As such, foreign exchange traders should keep a close eye on progress on tax reform, de-regulation and infrastructure in particular.
Q: Do you think inflation, which many thought would see a spike in 2017, has already reversed?
A: No. I think the recent U.S. reversal will prove temporary. I suspect that there is some more inflation in the pipeline in 2017 here, though I would not call it a spike – rather a slow move up.
Q: Would you be a buyer or seller of USD/JPY if the tensions on the Korean Peninsula escalate? How does that reconcile with BOJ’s stance?
A: An escalation of the geo-political tensions you postulate in your question would most probably lead to an appreciation of the dollar versus the Japanese yen – related to economic, financial and technical reasons. I suspect that, in such a scenario, and it is one of many, the Bank of Japan would allow the currency to depreciate rather than take measures to meaningfully counter the move.
Q: Would you be a buyer of gold in this period of heightened geopolitical tensions? Or do you see it underperforming in a rising interest rate environment?
A: Much depends on what else I have in my portfolio. Some allocation to gold makes sense here.
Q: Would you say the populist wave highlighted by the Brexit vote and the U.S. election is already waning given the French election left centrist Emmanuel Macron in the lead? And what is your view on the euro as a whole?
A: No, I think the anti-establishment phenomenon is still with us. Remember, Emmanuel Macron campaigned against the mainstream parties. In fact, he does not have a party – just a “movement.” What we are witnessing is the cumulative effect of too many years of low and insufficiently inclusive growth.