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The current market sentiment, anticipating a soft landing and a subsequent Federal Reserve pivot, has triggered the most significant monthly easing of financial conditions on record, according to economist Mohamed El-Erian. Speaking with CNBC, El-Erian acknowledged the growing consensus that the economy is heading towards a slowdown, prompting expectations of interest rate cuts in the coming year. However, he cautioned against excessive optimism, suggesting that the market may be overestimating the likelihood of recession-level rate cuts.
“While there is a market romance with the notion of a soft-ish landing, I think that’s probably too much of a romance,” El-Erian commented. The substantial easing of financial conditions has been evident in various indicators, such as the 10-year Treasury yield, which dropped from 5% in late October to below 4.3% a month later. This rapid decline has prompted discussions about a significant easing in financial conditions, potentially necessitating the Fed to reconsider its stance and even consider a rate hike.
Despite the market’s optimistic pricing in of rate cuts, El-Erian emphasized that the Federal Reserve has not yet lowered benchmark rates. He urged caution, noting that the current market expectations may be premature, especially given the Fed’s warnings against a hasty pivot to rate cuts.
The prevailing optimism has fueled a strong rally in stocks throughout November, with the S&P 500 surging approximately 9%. However, El-Erian expressed skepticism about the market’s projections, particularly the expectation of multiple rate cuts in 2024. He argued that the market’s anticipation of a 50% probability of a March cut and five cuts next year might be excessive unless a recession is imminent. In that case, equity markets should not be thriving as they currently are.
El-Erian expects the Federal Reserve to adopt a cautious approach, limiting interest rate cuts to around 100 basis points next year, in line with Barclays’ projection. The economist also highlighted the importance of monitoring forthcoming inflation data, suggesting that it might not be as encouraging as recent trends have indicated.
