The markets and the Federal Reserve have been engaged in a peculiar dance over the last year, with a large initial mis-alignment over the two parties’ interest-rate expectations having given way to a truce that could now be put at risk due to increasing market pressure on the central bank to cut rates.

The evidence for growing market discomfort with a Fed on hold includes, but isn’t limited to:

• Yields on U.S. government bonds have continued to drift lower, with 10-year Treasury yields trading on Monday more than 20 basis points below their mid-August high;
• The yield gap between two- and 10-year Treasuries has flattened for nine days in a row, narrowing to 14 basis points, compared to the recent high of 27 basis just two weeks ago; and
• Yields on five-year Treasuries once again dipped below those on two-year U.S. notes.

On the one hand, this mounting market pressure has been very gradual, especially when compared to previous episodes, so the significance may not be the same. And yet, it’s notable that these market moves have occurred despite Fed actions resulting in a significant step-up in liquidity, including purchases of Treasury bills and steps to stabilize the repo market that have made exceptional cash levels available to banks. It’s also confounding that the flattening in the Treasury yield curve — typically a sign of market expectations for a slowdown or contraction, as well as an equity sell-off — has occurred in the context of favorable market and economic developments.

U.S. stocks recorded yet another all-time high on Monday, adding to a rally that has seen the S&P 500 Index gain 9% in its current leg up that started at the beginning of last month.  The credit markets have also been well-behaved, with the exception of the lowest-quality segment of high yield, where spread widening has been widely attributed to narrow and specific company and segment drivers. And the last few weeks have seen further partial indications that economic conditions in  Europe may be bottoming, including Monday’s third successive monthly improvement in the Ifo measure of business confidence in Germany, the region’s economic powerhouse. This adds to the feel-good economic factors associated with the continued strength of the U.S. labor market, the easing of trade tensions between China and the U.S. and a solid quarterly earnings season.

Such competing impulses highlight the contrast that has been building up between supportive short-term economic and market dynamics and the much more uncertain medium-term prospects that go well beyond the still-fragile global economy and the significant further decoupling of asset prices from underlying fundamentals.  

Without greater clarity on this basic contrast, the challenge for investors continues to be how best to maintain a claim on the short-term upside while increasing portfolio resilience to navigate well the longer-term uncertainties. As best as I can see, this involves the gradual portfolio tweaks that I discussed before — such as moving up in quality — and whose relevance has been amplified by recent market and economic developments.

As for the Fed, I suspect officials there are hoping that markets will refrain from again placing undue pressure on them for further cuts. The last thing the Fed, or any central bank, wants is to be placed in a lose-lose situation: that is, either accommodating markets by cutting rates even though the economy neither needs it nor is likely to benefit from it; or resisting market pressures and risking a stock market sell-off that could have adverse spill-backs onto the real economy.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'