FLASH: The EU’s economy is cooling more than many investors believe, the slowdown poses the biggest risk to the market.
The European Central Bank (ECB) has limited tools at its disposal to respond to economic weakness while European governments are not prepared to respond with spending warns Mohamed El-Erian.
“People are underestimating how quickly Europe is slowing,” Mr. El-Erian said.
The International Monetary Fund (IMF) revised down its forecast for Eurozone growth to 1.6% in January down from 1.9% 3 months prior, but the lowered outlook is overly optimistic. But, El-Erian expects the Eurozone will struggle to deliver even 1% growth in GDP this year.
The potential spillover effects from a cooling in Europe and China helped push the Fed to signal in January that its interest rate hikes are on hold for the time being, saying that it would be “patient” before making any moves, after raising rates 4X in Y 2018.
“I suspect that, with continued solid US economic performance, the Fed will be forced to give a more nuanced message about the rates outlook which may in fact conflict with what’s priced by markets currently,” he said.
The Fed will have to signal the possibility of further rate hikes or a longer period of letting its massive bond holdings fall by Summertime, Mr. El-Erian said.
“I don’t believe this is the time for massive risk-on,” Mr. El-Erian said, adding that said he favors fixed-income securities within the 3-4 year range.
Looking at Europe: 5 of the region’s biggest markets; Britain, Germany, France, Spain and Italy are dealing with internal and continent-wide disagreements from BEXIT to fiscal spending that are toxic for growth.
He called Europe the top risk to global markets, followed by China’s slowdown, central bank policy and trade conflict.
The concern is that central banks are becoming less effective with rates negative in Europe and less appetite for other stimulus policies, from government spending to central banks’ buying assets.
“Central banks realize that the additional round of unconventional policies mean lower benefits, higher costs and risks, so they really want to normalize,” he said. But they may struggle with European governments unable to ramp up spending.
The ECB, which just ended a 2.6-T EUR bond-buying program aimed at pushing down borrowing costs, is already contemplating new support measures, with the 1st possibly coming at its next policy meeting, on Thursday.