El-Erian on the Meaning of the Market Rebound

A recent article by Bloomberg columnist Mohamed El-Erian discusses the implications of the robust rebound in U.S. stocks that occurred earlier this  month, noting that it “raised several questions related to market behavior, policy and economics,” adding that how these questions are answered will “prove consequential not only for market prospects but for the global economy.”

El-Erian argues that the equity rebound in the first week of June stood in contrast to two other market developments:

  • Government bond yields fell across the board, leading to a dip in the 10-year benchmark to below 2.10%. “The moves are good news for stock investors if they foresee more dovish central bank policies,” the article says, “but less so if they signal a lower global growth picture.” Investor money, it says, is flowing into bond funds despite low interest rates, begging the question: “Is it a sign of appropriate, forward-looking risk management or, instead, a backward-looking, pro-cyclical reaction that increases the vulnerability of investors to future losses?”
  • Given the sharp gains in U.S. stocks, the fact that several of the higher risk asset classes did not rally much seems strange: “Was this just a temporary phenomenon or the result of spreading concerns about the global economy?”

He also describes a “disconnect” between the rate cuts now baked in by the markets and the “consensus justification for such an aggressive policy move by the Federal Reserve.” Further, he writes, “the effectiveness of monetary policy is also an issue. The forces holding back growth, here and elsewhere, are not related to financial conditions” but rather are “reflective of structural and demand impediments to growth that lie outside the purview of monetary policy.”

El-Erian argues that the more the Fed cuts rates now, the more they dilute the efficacy of such a move to offset economic downturns going forward.

All of these issues, El-Erian writes, reflect the “clouds of uncertainty hanging over markets, policies and the economy.” And whatever challenges they present to the U.S. economy, he adds, “imply even larger challenges for the rest of the world. As such, it may not yet be time for investors to give up the multi-year bond and equity positioning that, in relative terms, has favored U.S. securities.”