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Pimco’s El-Erian: 3 Major Trouble Spots to Watch

Monday, 28 Nov 2011 09:43 AM

Pimco CEO Mohamed El-Erian says the next few weeks will see heavier emphasis on what happens to Europe's latest yield curve inversion, core bond rates, and policy announcements than on stock market performance.

"Curve inversions are often seen as indicative of a potential tipping point — when market perceptions of a liquidity problem risk turning into self-fulfilling solvency concerns," El-Erian writes at CNBC.

"As such, there is nothing good associated with last week's curve inversion in Italy, the third largest bond market in the world."

Moreover, says El-Erian, the longer it takes to stabilize Europe's core bond markets, the greater the risk that capital flows within the eurozone may become swamped by flows out of the region as a whole, thereby threatening a region-wide credit crunch, triggering further rating downgrades, and undermining consumption, investment and trade.

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Mohamed El-Erian
(Associated Press photo)
"These developments accentuate the pressures felt by markets that are already straining to function normally," EL-Erian says. "It is therefore critical for Europe, and more broadly for the global economy, that they be reversed quickly."

Finally, well-crafted policy announcements can normalize the Italian yield curve and stabilize the bond market for core countries if they involve simultaneous progress in five key policy areas:

• designing more appropriate reform programs for highly-indebted economies;

• providing for a more credible delineation between the region's liquidity cases and solvency ones;

• countering the deepening fragility of the banking sector;

• strengthening the institutional underpinning of the Eurozone, whether in its current configuration or a new one;

• and instituting a durable circuit breaker for what has been a continuous deterioration in market technicals that destroys private demand for European bonds.

"So, while last week's nearly 5 percent loss in the S&P 500 was the worst Thanksgiving-week loss since 1932, it is critical to stay on top of what is happening elsewhere." El-Erian says.

"With a number of important announcements coming up this week, the well being of many economies and markets around the world depends on European policymakers being able to reverse the additional damage incurred last week, particularly in Italy and core markets."

The Financial Times reports that bond yields on short-term Italian debt rose above 8 percent on Friday as Rome was forced to pay euro-era high interest rates in what analysts called an “awful” auction.

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Pimco CEO Mohamed El-Erian says the next few weeks will see heavier emphasis on what happens to Europe's latest yield curve inversion, core bond rates, and policy announcements than on stock market performance. Curve inversions are often seen as indicative of a potential...
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2011-43-28
Monday, 28 Nov 2011 09:43 AM
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