NEW YORK -- The world economy is chugging along slowly but fairly smoothly, underpinned by accommodative monetary policies. Prominent economist Mohamed El-Erian, however, does not share the widely held view that 2017 will bring more of the same.
While U.S. stocks continue to touch new highs amid the so-called Trump rally, the prospect of further Federal Reserve interest rate hikes is casting a shadow on emerging markets. Upcoming European elections, meanwhile, could unleash new political shock waves. El-Erian, who serves as chief economic adviser at Allianz, recently told the Nikkei Asian Review that the world economy's path is "getting less stable."
Q: How would you describe conditions in the global markets, following the election of Donald Trump in the U.S.?
A: Markets are being heavily influenced these days by the view that the U.S. now faces the possibility of both higher growth and higher inflation.
From the rise in yields on government debt and the stronger dollar to the rather exuberant stock markets, investors have embraced the pro-growth content of the president-elect's post-election economic remarks, together with the more inclusive tone.
Specifically, the markets' focus has been on Mr. Trump's emphasis on higher infrastructure spending, corporate tax reform and deregulation. And the president-elect's more inclusive tone has been met with constructive narratives by high-level officials from the "establishment," both Democratic and Republican.
Q: What is your take on the post-election stock surge? Is there still room for U.S. shares to rise?
A: Yes, they do have more room to run but only -- and critically -- if three domestic conditions are met: that pro-growth policy announcements give way to careful design and sustained implementation; that the Trump administration continues to refrain from the highly protectionist narrative that was evident during the campaign, together with one that also attacked the Federal Reserve; and that the inclusive political tone continues, opening the door for Congress to work with the White House and step up to its economic governance responsibilities.
Q: What about the rapid increase in Treasury yields? Is this part of the "Great Rotation"? Can investors in the U.S. quit worrying about ultralow rates?
A: The bond market has been pricing in changed economic expectations, compounded by a third policy effect -- namely, higher expectations of growth, inflation and interest rate hikes by the Federal Reserve. With that, fixed-income investors in U.S. markets have stopped worrying about the deflationary threat and the persistence of ultralow interest rates, at least for now.
Q: Do you see the U.S. economy accelerating under Trump?
A: Yes, the potential is there, though it is not a done deal.
Remember, the issue has never been the engineering of pro-growth policies. A majority of economists agree on what is needed. Also, President [Barack] Obama proposed to Congress several infrastructure, job and tax reform initiatives that were similar to what the president-elect has announced. The problem has been the extent to which political polarization in Congress paralyzed even the most basic elements of economic governance.
As a result of the elections on Nov. 8, the Republican Party now has majorities in both houses of Congress. With the initial rapprochement between Mr. Trump and the more traditional high-level officials of the Republican party, there is hope for unblocking the legislative bottlenecks as the White House and the legislative body now collaborate much more.
Q: For some time, the Fed has been the only game in town. Can the U.S. economy stop relying so heavily on the central bank?
A: Yes. It is the best-placed among the G-3 [Europe, Japan and the U.S.] to pivot away from "the only game in town" syndrome -- that is, to transition away from overreliance on the Fed and to a comprehensive policy approach that combines pro-growth structural reform with a more balanced demand management policy response. This, together with an accommodative global environment, would open the window for the Fed to gradually normalize its monetary policy in the context of overall economic and financial stability.
Q: While U.S Treasury yields are increasing, emerging markets are hurting. Can the emerging world overcome this?
A: A lot will depend on how individual emerging economies respond as capital gets re-allocated around the world because of the changed interest rate circumstances.
It is always important to recall that the EM asset class is very sensitive to changes in global liquidity conditions. And because crossover flows, or what I like calling "tourist dollars," are much larger than dedicated flows [or "local capital"], the asset class is vulnerable to overshoots, both on the way up and on the way down.
The best stabilizer in these conditions is domestic policymaking that maintains sound macroeconomic conditions, comfortable international reserves and careful liability management.
Q: Europe is facing key elections in the Netherlands, France and Germany. Do you think anti-European Union sentiment will gain ground in these countries?
A: Europe is in a rather fluid political environment, including on account of the influence of anti-establishment movements, which have grown in response to the protracted period of low and insufficiently inclusive growth. Combine this with a tendency of voters to be very heavily influenced by single issues, and the scope for unusual outcomes becomes unusually high.
How all this will evolve exactly is hard to predict. Interestingly, it's not just about anti-establishment movements. In France, Francois Fillon has surged, essentially as an establishment figure that has adopted certain anti-establishment elements. And, in Austria, the ultra-right candidate stumbled in the recent rerun of the presidential election.
All this speaks to the important concept of "unusual uncertainty."
Q: What went through your mind when you saw the outcome of the U.S. election?
A: Like many others, I was surprised, but I was not shocked. I was surprised because the polls and expert opinion were all strongly predicting a win for Secretary [Hillary] Clinton. Not shocked because Brexit had illustrated how strong anti-establishment movements can be.
Q: What lies ahead in 2017?
A: I must admit that I am nervous about the strong consensus view that 2017 will be more of the same for the global economy -- that is, low and stable growth, coupled with central banks being able to repress financial volatility. It would seem to me that from an economic, financial, political [and] institutional perspective, the current path the global economy is on is getting less stable. Underlying tensions and contradictions are growing. That's why more improbable [developments] have become realities.
I think 2017 will see the global economy get a lot closer to an inflection point, or what I call a "T junction."
If the political class steps up to its economic governance responsibilities, low growth would turn into high and more inclusive growth, and artificial financial stability would give way to genuine financial stability. If, however, the political class fails to step up, low growth would become recession and genuine financial stability would turn into unsettling volatility.
There is a lot at stake -- not just for current generations but also for future ones.
Interviewed by Nikkei staff writer Akira Yamashita
