Tags: El-Erian | Fed | meeting | policy

Pimco's El-Erian: Taper Forces Fed to 'Walk Quite a Tightrope'

By    |   Thursday, 19 December 2013 12:10 PM

Pimco CEO Mohamed El-Erian says financial markets were justified in soaring Wednesday on the Federal Reserve's policy pronouncements. And he sees four important points to be made about the Fed's moves.

"First, the Fed is right to be more confident about the short-term outlook for the economy," he writes in a commentary for CNBC. Recent reports on jobs, household spending and business investment indicate strength, El-Erian says. And Congress' budget agreement lessens fiscal restraint.

The economy added 203,000 jobs in November, and the unemployment rate dropped to a five-year low of 7 percent.

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"Second, the Fed's confidence, while higher in relative terms, is not yet overwhelming," El-Erian writes.

Fed officials are still worried — and justifiably so — by sluggish economic growth and high unemployment, El-Erian explains. There is some concern about inflation being too low as well, he notes.

"Third, this mixed outlook calls for a very delicate policy balance, with the Fed having to walk quite a tightrope." This explains why in addition to announcing a tapering of its bond buying, the Fed offered even more dovish language on the federal funds rate, El-Erian argues.

The central bank is making clear to investors that the record low fed funds target rate will stay steady for longer than experts previously expected, he adds.

"Fourth, the Fed did not use up all of its remaining policy flexibility, low as this already is. For example, the interest it pays banks on excess reserves was left unchanged at 0.25 percent."

The Fed remains committed to boosting the economy through financial markets, El-Erian believes.

"This is particularly good news for equity markets in the short term, building on what already has been a great performance year," he says. "It also contains the disruptions to bonds."

The Fed has a difficult proposition for success, El-Erian contends. "[It] needs to succeed in a very tricky economic handoff: from policy-induced growth, fueled by prolonged reliance on experimental measures, to more durable genuine private sector-led growth."

That would entail a significant rise in business investment and more coherent policy out of Washington, El-Erian says.

Meanwhile, Barry Eichengreen, an economics professor at University of California, Berkeley, sees the Fed's policy moves as only a minor shift.

"The decision by the Federal Reserve to reduce the monthly rate of security purchases by $10 billion is best dismissed as a taper in a teapot," he writes in the Financial Times.

"In effect, the Fed tightened current monetary policy almost indiscernibly, while at the same time using forward guidance — that is, the statement by the Federal Open Market Committee — to indicate that future policy would remain loose for at least slightly longer than previously anticipated."

Eichengreen thinks the Fed did the right thing. "This was a sensible way of tweaking the time profile of monetary policy," he writes. "The economy has been doing a little better than expected of late and can therefore digest this slightly tighter policy now."

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Pimco CEO Mohamed El-Erian says financial markets were justified in soaring Wednesday on the Federal Reserve's policy pronouncements. And he sees four important points to be made about the Fed's moves.
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2013-10-19
Thursday, 19 December 2013 12:10 PM
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