El-Erian Pours Cold Water On Market Convergence Hopes, Says It's Wiser To Brace For Bumpier 2nd Half

Even the most pessimistic analysts are throwing in the towel and conceding that they were wrong. Against that backdrop, top economist Mohamed El-Erian said it may be too early to call for a period of convergence – a period when the economy and financial markets are moving together.

Growing Evidence Of Convergence: Forecasting a convergence and the favorable set of outcomes that would come with that, from better growth and inflation results to rewarding investment performance, would be premature and unwise, said El-Erian in an opinion piece for Financial Times.

The economist noted that the U.K., which is typically a laggard in reining in inflation, reported surprising lower-than-expected inflation data in July. With the potential convergence of U.K. inflation with the rates prevailing in the rest of the G7 economies, he sees the Bank of England's monetary policy converging with the European Central Bank and the Federal Reserve and opting for a 25 basis point hike.

El-Erian also noted that the Dow Industrials is playing catch-up with the Nasdaq Composite Index after notably lagging behind the latter. Among the global markets, China, which underperformed the advanced and emerging economies, has outperformed these two in July, he said.

Also, the threat of U.S.-China decoupling has given way to the idea of de-risking that would neither derail growth and trade nor cause notable financial instability, El-Erian said.

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Caution Advised: El-Erian said it would be wiser to plan for a bumpier road despite the temptation to believe the second half of the year will see an alleviation of uncertainties in the global economy and financial markets.

He pointed to some of the factors that could complicate the convergence that is getting entrenched. The BoE still has a tough road ahead in its inflation fight and the Fed and ECB may have to strike a trade-off between the 2% inflation target and maintaining financial and economic stability, he said.

The economist also said the Bank of Japan has the tough ask of making more drastic adjustments to its yield curve control.

El-Erian said an anemic manufacturing sector and depleted savings may not offer fundamental support to market-wide price gains and the rally in a small set of stocks, riding a huge secular wave, mainly AI may not compensate for this.

He is not too positive about the Chinese economy, which is facing both cyclical and secular challenges.

The failure to “moderate the pull of the comforting convergence narratives" will not only translate into a premature relaxation of the efforts needed to overcome remaining short-term challenges but will also leave us in an even worse position, the economist said.

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Photo by International Monetary Fund on Flickr