Donald Trump wasn’t the only one to snatch victory from the jaws of defeat in recent months, says Mohamed El-Erian, chief economic adviser at Allianz and former CEO of Pacific Investment Management Co.
The avid sports fan, known for wearing a New York Jets jersey in his TV appearances, sees a parallel in last month’s Super Bowl. “Expecting the unexpected is becoming a lot less rare these days,” he told me in a recent e-mail exchange.
Few expected the New England Patriots to climb back from a 28-3 deficit late in the third quarter of the Super Bowl, when they were losing to the Atlanta Falcons. “But then, few expected the U.K. to vote for Brexit, Donald Trump to win the U.S. presidency, and over 30 percent of global government debt to trade at negative yields last year,” El-Erian, former chief manager of Harvard University’s endowment, points out. “So add the Patriots’ historic comeback to the growing list of realities that not so long ago were improbable, if not unthinkable.”
Given the stinging defeats that his beloved Jets have suffered at the hands of the Patriots over the years, El-Erian, 58, wasn’t surprised by New England’s Super Bowl rally. “For over a decade now under the powerful Belichick–Brady combo, I have gotten used to New England doing some amazing things.”
While Trump is famous for his combative nature and thin skin, El-Erian is quite the opposite. That’s not much of a surprise given that his father was a diplomat, working at the United Nations and serving as Egypt’s ambassador to France. Though he had no time to sit for an in-person interview — Institutional Investor’s preferred way of doing things — El-Erian, whose long-respected views are even more in demand since the election, graciously agreed to answer all of my questions via e-mail. He was unfailingly polite in our correspondence, replying to my queries quickly and graciously.
It certainly fits the economist’s character that he kept quiet after leaving PIMCO despite public attacks by the firm’s mercurial co-founder Bill Gross. It’s also no surprise that El-Erian, educated at Cambridge and Oxford universities, writes in patrician English.
As for Trump — who has claimed support from Patriots coach Bill Belichick, star quarterback Tom Brady, and owner Robert Kraft — his economic policy has the potential to do great good or great harm, El-Erian says.
Trump has offered two visions for his policy, one that would be fruitful and one that wouldn’t, says the economist, who knows a thing or two about policymaking from his days as deputy director of the International Monetary Fund.
“The first approach revolves around three pro-growth themes: deregulation, infrastructure [spending], and tax reform,” El-Erian says. “If these measures are well designed and implemented carefully, they have the potential to boost economic growth.”
Then there’s the downside. “The second set of policy announcements worries markets a lot more, and understandably so,” he explains. “It speaks to trade protectionism, including the possible dismantling of [the North American Free Trade Agreement], the termination of bilateral free trade agreements, and the imposition of punishing import tariffs on China and Mexico.”
It’s unclear whether the darkness or the light will win out, El-Erian says. And that’s not up just to the president.
“Congress will have an important say, particularly when it comes to tax reform and the infrastructure program,” says the former chairman of president Obama’s Global Development Council.
If the focus is on deregulation, infrastructure spending, and tax cuts, economic growth could be boosted by both the supply side, including productivity growth, and the demand side, thanks to fiscal expansion. That fiscal expansion “would also allow for an orderly normalization of monetary policy,” El-Erian says.
The other possibility is less positive. If protectionism wins out and leads to trade wars, the outcome could be stagflation, “that nasty combination of low growth and high inflation that the advanced countries haven’t experienced since the early 1970s to early ’80s,” El-Erian says.
In terms of their impact on financial markets, the “good” Trump policies would boost stocks and the dollar because of stronger growth, higher inflation, and capital flows to the U.S., the economist figures. “It would also push government yields higher while containing risk spreads on emerging markets and corporate bonds, including high yield.”
The “bad” Trump policies would have a quite different effect, he says. “They would be detrimental to stocks, with more ambiguous effects for the dollar.” Slower growth is bearish for the dollar, but a trade war and higher inflation might buoy the greenback. In the bond market, “government yields would find themselves in the midst of a tug of war between the impact of lower growth on one hand and higher inflation and less foreign bond buying on the other,” El-Erian says.
Trump isn’t the only source of potential trouble for financial markets and the global economy, El-Erian says. There’s the risk of political turmoil in Europe with the rise of the xenophobic right wing. “And there’s a possibility of the dollar getting too strong too quickly, thus fueling political issues at home and dislocating” foreign governments and corporations with heavy dollar-denominated debt burdens, he says.
Although much of the financial world’s focus is on Trump, Federal Reserve policy remains important. El-Erian thinks the Fed should be moving a bit more quickly to exit its accommodative stance. He wrote of the limits of central bank easing last year in his book The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.
“While I understand the reasons for the Fed being inclined toward ‘low [rates] for longer,’ I see the case for a somewhat faster policy normalization,” El-Erian told me.
By that he means quicker interest rate increases and more-hawkish policy guidance. “I believe this is warranted by the economic data and would serve to lower the risk of financial instability down the road.” The economy grew an annualized 2.7 percent, on average, in the third and fourth quarters.
The Fed raised rates once in 2015 and once in 2016. Officials estimated in December that they will lift rates three times this year; El-Erian sees that as the most likely outcome, even though the federal funds futures market points to only two moves. “And the balance of risk is tilted slightly to more than three should Trump, working with Congress, deliver on his infrastructure and tax announcements,” El-Erian says.
Trump has indicated that he won’t reappoint Fed chair Janet Yellen when her term expires next year. Some analysts are worried that he might replace her with someone far outside the mainstream. But El-Erian isn’t too concerned. “So far, President Trump’s appointments in the economic domain have been appropriate,” he says. “As such, I don’t worry about whom he appoints should he choose not to keep Yellen for a second term.”
But perhaps we should expect the unexpected again.
