US Fed should resist urge to extend stimulus, El-Erian says

Benefits of further monetary stimulus are minimal, but costs and risks are increasing, economist argues

The US Federal Reserve should "sit on its hands", instead of taking further quantitative easing measures, as the potential risks of taking more action outweigh the likely benefits, the president of Queens’ College at the University of Cambridge and chief economic adviser to Allianz said.

"I think most people agree now that the economic benefits of more QE are de minimis, but more importantly, the costs and risks are going up," Mohamed El-Erian said during a webinar organised by the AIM Summit and brokerage company Equiti.

"So what the Fed should do is sit on its hands. But what the Fed will do is be even more dovish."

The Fed's Open Market Committee, which sets monetary policy, is holding its final meeting of 2020 on Tuesday and Wednesday.

The US central bank has already taken drastic measures to mitigate the economic fallout from the Covid-19 pandemic this year, cutting interest rates to near-zero and embarking on an asset purchase programme that is buying up about $120 billion of securities every month.

That includes $80bn of bonds and around $40bn of mortgage securities.

The Fed has assumed a role in the US economy as "not just a first responder, but the constant responder" as it can continue to take action without having to rely on approval from Congress, whereas fiscal stimulus measures need to secure partisan support from lawmakers, Mr El-Erian said.

"So what you get is risk aversion. And in a situation like that, the Fed will feel that it has no choice but to do more," he said.

"So expect the Fed to at least give us very reassuring guidance on QE, basically telling us it's not just low for long on rates, it's long for long on QE. And that will continue this process of providing markets with enough assurance of liquidity."

The European Central Bank, which last week injected a further €500bn ($604bn) into its bond-buying programme, taking the total thus far to €1.85 trillion, is confronted by an even more difficult scenario than the Fed, Mr El Erian said, with Europe facing a double-dip recession, higher levels of uncertainty, a currency that is too strong and a market that expects further intervention.

"If you're facing these four things, which the ECB faces, I would say you have no choice but to try and do more," he argued.

The short-term trade-off ECB policymakers face, is "doing more and not having it be very effective, than doing less, causing financial instability that can then go back onto the real economy".

There are currently four major economic themes that explain "about 80 to 85 per cent of what we're going through", Mr El-Erian said.

The first is inequality, with Covid-19 proving to be "the great unequaliser" in terms of widening inequality of income, wealth and opportunity.

The second is dispersion, with countries such as China set to grow at 2-3 per cent this year, while the UK contracts by 11 per cent and Spain by about 16 per cent.

The third is the long-term "scarring" effects that can be caused by the crisis, such as unemployed people remaining out of the workforce for longer, making them more difficult to employ in the future, and the fourth is "the great disconnect" between stock markets and the real economy.

"If you're in the financial sector, it's hard to believe that we've gone through a generation-defining moment," he said.

During his former career as chief investment officer at Allianz's subsidiary, Pimco, Mr El-Erian said the question that was always asked when making trades was "who will buy after us?".

The massive injection of liquidity into markets by central banks means there is now a buyer for many assets "at any price".

"QE, which has had massive ripple effects, is nothing more than ample unlimited purchases of securities at non-commercial levels," he said.