Taps Coogan – May 22nd, 2021

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Mohamed El-Erian, Allianz chief economic advisor, recently spoke with CNBC to explain the recent Tech Sector weakness.

CNBC’s Joe Kernen asks whether the weakness is due to concerns over the Fed pulling forward the trajectory for tightening policy, to which Mr. El-Erian basically says ‘no’:

“If they (markets) thought that the Fed was going to change it’s policy course… you would see the 10-year move. No, this is something else Joe. This is the markets worried that the Fed will be late. That’s why you get the market itself starting to question the liquidity paradigm because if the Fed turns out to be late, then the Fed may have to slam on the breaks. So what you’re seeing is nervousness, not that the Fed will move, otherwise the 10-year would be much higher in yield, but nervousness that the Fed will be stubbornly holding on to its transitory mantra about inflation while other central banks are changing course and other people are saying ‘Hey, look at the evidence on the ground.’”

Mr. El-Erian says that the market isn’t worried that the Fed will tighten, it’s worried that it won’t. 

That’s probably correct, however, I’ll put forward a slightly different explanation for why markets are softening up, Bitcoin has crashed, inflation is jumping, and yet 10-year yields aren’t meaningfully rising.

I see it everyday: very smart people warning about runaway inflation and then, in the next breadth, warning about a 2001 like crash in financial markets.

On one hand, monetary and fiscal policy in the US has become so unhinged that despite inflation well above the Fed’s target, the Fed is still using terminology like ‘not thinking about thinking about a plan to eventually taper’ its extreme monetary policy.

So, everyone is justifiably worried about inflation, but at the same time, financial assets are the most expensive they’ve been since 2000 or 1929, and in many cases more expensive. Hence, everyone is also worried about a classic bear market caused by a historically overindebted over-financialized economy with glaringly obvious signs of excessive speculation. 

Now anything is possible, but not even Venezuela could manage to pull off a bear market in equities and hyper-inflation at the same time. 

So which is it, runaway inflation or 2001? The fact that that is a relevant question is what has markets skittish. In other words, the market is worried the Fed will tighten and it’s worried it won’t.

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