El-Erian: 70% chance of December rate hike

By all accounts, the Federal Reserve seems ready to act in December and raise interest rates by 25 basis points. Mohamed El-Erian, chief economic adviser at Allianz, puts the likelihood of that timeline holding at 70%.

El-Erian notes that this week’s release of FOMC meeting minutes from October shows that Janet Yellen and company “are less worried about the international context and in particular the adverse spillovers onto the U.S. economy of a slowing global economy.” Still, he believes that the global economy is a fluid one and geopolitical events, such as last week’s attacks in Paris, make it difficult to say with absolute certainty that a rate hike is coming by year’s end.

Perhaps even more important is that El-Erian believes we are all “over obsessing about 25 basis points.” He believes the first step of zero percent interest rates is less important that the continued process of evaluating the economy and reacting in kind.

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He predicts that this will be “the loosest tightening in Fed history” and that three things will characterize the rate hike journey in the longer term: the path will be very shallow; it will not be an automatic 25 basis points every meeting but instead will “have stop-and -go characteristics;" and that the final destination for rate will be lower than it has been in the past.

So what does it all mean for investors? El-Erian believes that since the stock markets shrugged this week when the minutes were released shows that it is less concerned with the minutia of the rate hike and instead is more focused on the broader topic of liquidity in general. Namely, do central banks around the world (ECB, Bank of Japan, the central bank in China etc.) continue to push policies that create safe environments for stocks? So far he thinks the answer has been “yes.”

In addition to global central banks El-Erian thinks corporate cash plays a big role in market success in the short term and specifically if that cash is returned to the market as dividends, buybacks and M&A.

The longer-term success however depends a bit more on the aforementioned Fed policy.