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El-Erian: One of three things needs to happen to alter the course of markets

Emily McCormick

U.S. stocks have continued to make fresh record highs and build on last year’s thumping returns due in large part to the Federal Reserve’s monetary policy actions, many market pundits have agreed.

That boost, however, could reverse in the event that one or more shock scenarios transpired, according to Mohamed El-Erian.

“It’s either going to be a major policy mistake or a liquidity accident – an endogenous liquidity accident in markets,” El-Erian, chief economic adviser at Allianz, said during Yahoo Finance’s On the Move on Thursday. “Or on the third one, a very big geopolitical shock. A very big one.”

The first two points speak to El-Erian’s oft-repeated affirmation that central banks, and the Fed especially, serve as the most important policy actors for markets.

The Fed stunning reversal to lowering interest rates last year, in tandem with its end-of-year return to balance sheet expansion and injection of hundreds of billions of dollars in liquidity to the financial system, has supported markets even as political and geopolitical uncertainties flared. However, it’s also created a potentially dangerous expectation that the Fed will always be able to come to the rescue.

“I keep on cautioning, be careful that you cannot bet on liquidity long-term. Yes, the Fed did a dramatic 180 a year ago,” El-Erian said. “Yes, the Fed led other central banks to also follow it in policy loosening. But you can’t repeat it over and over again.”

Mohamed El-Erian. REUTERS/Jason Reed
Mohamed El-Erian. REUTERS/Jason Reed

And for his third point, El-Erian emphasized that it would take a major, catastrophic geopolitical or political shock to jolt markets off their current course.

Recent developments in U.S.-Iran tensions failed to breach that threshold.

Though Iran’s supreme leader promised retaliation after a U.S. airstrike took out a top Iranian military commander last week, the eventual reprisal – a series of drone attacks in Iraq that produced no reported casualties – was viewed as largely benign. And President Donald Trump, in remarks Wednesday, further tempered fears of an armed confrontation with Iran by suggesting a U.S. response would take the form of sanctions.

“Had we gone to war with Iran, I would tell you that’s a very big geopolitical shock,” El-Erian said. “But an escalation and then a de-escalation? No. The market sets that aside. So you need one of three things, or more than one to happen.”

Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck

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