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b"With Mohammed El-Erian, Chief Economic Advisor at Allianz SC, Chairman of President's Global Development Council
Federal Reserve Normalizing in 2017?
Shifting gears to interest rates and the Federal Reserve, Steve raises the possibility that, in addition to its announcing two more rate hikes for 2017, the Fed is also signaling its readiness to unwind its balance sheet by selling some of the $1.7 trillion in mortgages and $2.5 trillion in Treasury securities that it purchased to stabilize the financial system in the aftermath of the global market crash in 2008.\\xa0 Steve wonders whether this action would bring the market and the economy \\u201cback to reality\\u201d?\\xa0 El-Erian thinks that the Fed wants to move away from being \\u201cthe only game in town\\u201d in terms of supporting markets and that the relatively healthy state of the economy at the moment offers them \\u201ca window for it to start its normalization process.\\u201d This normalization includes easing measures to keep interest rates extremely low and getting out of the business of buying securities, upending policies which the Fed has been committed to for the past nearly nine years. El-Erian also remarks that he expects \\u201cat least\\u201d two more rate hikes this year, suggesting that he wouldn't be surprised by further increases.
So what does this mean for markets?\\xa0 El-Erian says there will be less support in terms of cheap money (i.e.rates and liquidity) but that markets are reassured by the fact that the Fed wants to exit or normalize in a very orderly fashion. There's no market panic yet because markets still believe that the Fed will have their back if needed.\\xa0 El-Erian expects higher market volatility for 2017/2018 as central banks in the US, Japan, and Europe withdraw support from buoyant markets. He contends that this situation relates back to his belief that the three elements of the \\u201cNew Normal\\u201d\\u2014which have aided a muted growth/low volatility scenario\\u2014are at risk of breaking down. At this point, we're either going to pivot to high or low growth, not stay on the same unsustainable course. One facet of this impending change is that politics in Europe are especially uncertain and this is already affecting economies in the form of BREXIT, with the possibility of further European Union defections to come.
Foreign Markets Outperform US Stocks in 2017
Steve points out that foreign markets have been performing better than domestic in the past couple of months and asks El-Erian why that is.\\xa0 He answers that it\\u2019s primarily because of rotation and lag: rotation meaning that investors are seeking other sectors that have not been as overbought as US equities and lag essentially being another way of saying the same thing\\u2014foreign markets were left behind in the initial run up in stock prices after the US election.\\xa0 Financials and industrials were the first to gain from the \\u201cTrump effect.\\u201d Other domestic sectors like tech followed and, soon after, so did foreign and emerging markets, which continue to be seen by many as underpriced even though they have risen sharply, while the US equities have gone flat. Emerging market sovereigns are also better prepared for a Fed interest rate hike than many US companies, thanks to reductions in their debt and increases in dollar reserves over the past several years. That said, it's still important to look at countries individually.\\xa0 In El-Erian's estimation, if you buy into the US stock market today, it's because you expect Trump and Congress to deliver growth policies.
Steve observes that yields on longer-term Treasuries recently declined after a brief rise, indicating that buyers are still pouring in (demand for bonds raises their prices and lowers their yield).\\xa0 Short-term yields, meanwhile, have risen on the back of increases in the Fed Funds rate. This reduction in the spread between long-term and short-term yields is called a \\u201cflattening yield c..."