Central Bank Bingo with Mohamed El-Erian

The world’s largest central banks are once again dominating the chatter among traders and economists. Last week, the European Central Bank announced additional measures to simulate the moribund Eurozone; this week, the Bank of Japan will weigh potential action after its surprise decision to adopt negative interest rates in January; and the U.S. Federal Reserve will likely refrain from a rate hike at its two-day policy gab fest. The heightened central bank focus made last week a perfect time to interview Dr. Mohamed El-Erian, author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. El-Erian is Chief Economic Advisor at Allianz, chair of President Obama’s Global Development Council and a LinkedIn Influencer. Between December 2007 and March 2014, he was chief executive and co-chief investment officer of global investment management firm PIMCO.

I sat down with El-Erian during a LinkedIn webcast to discuss how far the economy and markets had come since the bear market lows of March, 2009 (the S&P 500 has soared over 240 percent, including reinvested dividends), as well as the significant challenges that still lie ahead for investors and for the global financial system.

As markets bottomed seven years ago, El-Erian and his PIMCO colleagues coined the phrase “The New Normal” to describe what was likely to be a slow growth economic recovery. That prediction was spot-on: the U.S. is now in the seventh year of 2 to 2.25 percent GDP. El-Erian credits the actions of central banks for even that measly pace. When it became clear that government stimulus plans were not large enough, central banks were forced to adopt a “Whatever it takes” mentality. In doing so, they were able to avoid a multi-year depression.

Unfortunately, the unintended consequence of aggressive central bank actions was an environment where investors relied on monetary policy to do the heavy lifting to promote growth. That reliance encouraged excessive risk taking, which helped drive up asset prices beyond economic justification and turbo-charged income and wealth inequality. (Those who already owned assets were the biggest beneficiaries.)

It’s not as if the Fed, the ECB and the Bank of Japan don’t get it, but just when global central banks are looking to hand off the responsibility of promoting growth, there seem to be no takers.

So where do we stand right now, seven years after we bottomed out? We have come to what El-Erian calls a “T-Junction”. As we approach the end of this recovery road, there is an equal probability that we turn left and right. On one side of the T, we remain in a stable, but slow growth world, riddled with high unemployment, increasing income inequality and political extremism. On the other side, we have politicians who wake up and get serious about creating an inclusive economy; make pro-growth structural reforms, remove debt overhangs in problem areas like student loans and get the overall architecture right. The result would be higher growth, job creation, decreasing income inequality and a drop in financial instability.

Could the stakes be any higher this political season? That’s why El-Erian says that we desperately need candidates to acknowledge the anger that the “inequality of opportunity” can breed; and then to address that anger with policies that promote inclusive growth and restore faith in the system. In other words, we need an “Economic Sputnik” moment. Perhaps that seems like a distant possibility this moment, but El-Erian remains optimistic that one can occur.

MARKETS:

• DJIA: 17,213 up 1.2% on week, down 1.2% YTD
• S&P 500: 2022 up 1.1% on week, down 1.1% YTD
• NASDAQ: 4748 up 0.7% on week, down 5.2% YTD
• Russell 2000: 1087, up 0.5% on week, down 4.3% YTD
• 10-Year Treasury yield: 1.98% (from 1.88% a week ago)
• Apr Crude: $38.50, up 7.2% on week 7.2%, 4th straight weekly climb
• Apr Gold: $1,250.80, down 0.9% on week
• AAA Nat'l avg. for gallon of reg. gas: $1.92 (from $1.81 wk ago, $2.45 a year ago)

THE WEEK AHEAD:

Mon 3/14:

Tues 3/15:

Bank of Japan meets

FOMC Meeting Begins

8:30 PPI

8:30 Retail Sales

8:30 Empire State Mfg Survey

10:00 Business Inventories

10:00 Housing Market Index

Weds 3/16:

8:30 CPI

8:30 Housing Starts

9:15 Industrial Production

2:00 FOMC Decision

2:00 FOMC Economic Projections

2:30 Janet Yellen Press Conference

Thursday 3/17:

8:30 Philadelphia Fed Business Outlook Survey

10:00 JOLTS

Friday 3/18:

10:00 Consumer Sentiment