Leading economist El-Erian gives his take on the Fed, fixed income and why cash is king

Poor communication by the U.S. Federal Reserve is leading to higher bond market volatility, said leading economist and fixed-income expert Mohamed El-Erian in a Twitter Spaces interview Nov. 2.

In an interview with Pensions & Investments Editor-in-Chief Jennifer Ablan, El-Erian noted that the last day or so in the U.S. bond market has been "good, because rates (in the Treasury market) have collapsed. But these sorts of moves should not be happening in a benchmark market." El-Erian is also president of Queens College, University of Cambridge.

Why has there been increased volatility in the U.S. Treasury bill and bond market?

"Inconsistent communication from the Fed," El-Erian said. At press conferences, Fed Chair Jerome H. Powell "doesn't stick to the script. He says things and the market gets carried away. At the Economic Club of New York, the market was calm after his prepared remarks. Then he started talking, and next thing we saw yields traded from 4.89% to 4.99% based on his comments."El-Erian also cited recent research that found the U.S. bond market's volatility is four times higher than under previous Federal Reserve leadership. "We've lost our anchors," he said. "We're operating in a world without three anchors of predictable global growth, credible policies and supportive technicals. That's why conventional wisdom has been all over the place."

"There are two views of why we get rate cuts: one is, the Fed is forced into it because something breaks, like an economic recession or something breaking in the system. That's not a good way to get rate cuts, to be clear. It's not good for financial markets. The second way: because inflation comes down."

In 2023, "people are recognizing that we'll be higher (rates) for longer. Next year is going to be, where are the buyers for Treasuries? And we are going to be running significant fiscal deficits. In addition, a lot of the (U.S. government) refinancing is going to involve a doubling or tripling of the interest rates on the debt being refinanced. So there is going to be a major funding need that has to be met from somewhere. Your most reliable buyer, the Federal Reserve, is now de facto the seller. It is reducing its balance sheet.. So you won't get your reliable buyer ... who is price insensitive."

El-Erian said the Fed's 2% goal for inflation is somewhat artificial, and that 3% is more feasible.That said, "I don't think the Fed will allow any change in its 2% inflation target for understandable reason. If they missed it for so long, if they change it, they undermine credibility more." In his opinion, "if we didn't have 2% as target, would we choose it? We wouldn't. We'd probably aim for 3%."

The BOE's monetary policy committee voted 6-3 to hold interest rates steady at 5.25% on Nov. 1, which El-Erian said was "rightly so" a close decision. "Because while the growth dynamics in the U.K. are much more fragile than in the U.S., the inflation dynamics are more problematic."

Part of that is due to wages and part is due to complications in supply chains for the U.K. due to Brexit. "This is quite a difficult maneuver that they're going to have to do. I don't think they'll be in any hurry to cut interest rates. But the economy is weaker," partly due to the fact that the average maturity in the U.K. mortgage market is two to three years — "so people are refinancing at much higher rates, which takes spending away from elsewhere. So it is much more complex than for any other central bank, and that's why you see these really close votes," El-Erian said.

Once a holder of bitcoin, El-Erian said he largely exited his position after buying at $4,000 and selling at $19,000.

"But it went up to $68,000, so my selling decision wasn't a good one! I learned a lot in the process of how the market functions. I'm no longer a significant investor" in bitcoin.

He added of his portfolio, "I have a barbell, tactical toward public bonds and stocks, but well below normal levels. I'm worried about liquidity. We live in a volatile world."

"If you look at public stocks and bonds, we've suffered the worst of all worlds. Negative returns on both, unusual volatility and a breakdown in correlation."

El-Erian said: "I've been heavily in cash, more than most other people and on other side of barbell, in private credit, litigation finance, micro opportunities that address a market failure. I'm looking for the day I have more exposure to stocks and bonds, and it will come in 12 to 24 months."

And he remains a fan of cash. "Relax the notion that cash is trash," he said.