(Kitco News) – The Trump administration’s incoherent messaging on tariffs is exacerbating the market turmoil they’ve caused, and the Federal Reserve will not come to the market’s rescue, according to Mohamed El-Erian, Former CEO of PIMCO and current president of Queens’ College, Cambridge.
On Sunday, El-Erian was asked whether he believes Trump’s massive trade tariffs are designed to force negotiations with tariffed nations, or whether they represent the long-term new paradigm for trade with the United States.
“We don't know,” he answered, “because as much as there was uniformity when it came to statements on where we are going to end up, which is this notion of golden age in which tariffs play a critical role in getting us there, we've heard at least three different messages about the short term.”
El-Erian said the first message came from Treasury Secretary Scott Bessent. “There's nothing to worry about, this rush by Wall Street and others to price in lower growth, recession,” he paraphrased. “In the secretary's view, that is excessive; there's no need to do that. So he's saying everything is fine in the short term.”
The second view to come out of the Trump administration is one of real short-term pain for long-term gain. “Yes, it's going to be tough in the short term, but it's worth it because these tariffs will hold and what you're going to get is higher revenue, what you're going to get is protection, what you're going to get is people moving back to the US with their production facilities.”
“Then you had a third view expressed that we have 50-plus countries negotiating, and we may go into a world where tariffs are uniformly low across the world,” he said. “I think the hardest thing for the markets right now is not only to try to evaluate where the destination is, but how bumpy will the journey be?”
El-Erian said this incoherence on the part of the administration – and the resulting confusion among market participants – is already having impacts that are impossible to contain in a modern trading environment.
“We have technicals playing in,” he said. “Margin calls are there. People are, in fact, reducing winners and losers across the board to raise cash. Fund managers are worried about actual and expected outflows. There is no ‘circuit breaker’ on the horizon.”
With this confusion about what's happening in the short term, will that technical take over?” he asked. “That's the big question right now.”
Asked whether the dramatic but relatively orderly repricing of risk seen since Wednesday could give way to something more chaotic in the coming days, El-Erian said he could see two potential paths.
“On the one hand, this sell-off has been quite indiscriminate,” he said. “Correlations across asset classes have gone to one, whether it's equities or gold, the correlations have gone positive and high-positive, and therefore value is being created in certain pockets of the market.”
“On the other hand, people are worried about catching a falling knife,” El-Erian added. “They're worried about more de-leveraging. They're worried about the margin calls forcing people to raise cash. You've got to be really brave to go in and pick up the pockets of value because there's still a very big technical cloud over your head.”
El-Erian was then asked whether the latest round of sell-offs is traders coming to terms with the fact that the Federal Reserve will not cut rates to rescue markets.
“It is because we first priced out the Trump put, and then what we heard from Chair Powell on Friday is that the Fed put is well out of the money,” he said. “If you look at the latest revisions in inflation, JP Morgan this weekend has PCE inflation at 4.4% by the end of the year – more than twice the Fed's inflation target.”
He added that it would take not just a declining market, but a breaking market to force the Fed’s hand.
“When you look at what happened in 2020, you need a malfunctioning of markets in order for the Fed put to be back in the money, he said. “You need markets to malfunction. You need treasuries not to be the safe haven, but to start showing technical breakdown, and we haven't seen that.”
“Unless there's a malfunctioning of the market, the Fed is forcibly sidelined by the inflation side of its mandate.”
Asked what he’s hearing from the highest levels of the business community, El-Erian said the views are divided there as well.
“There's a set of business leaders who are willing to wait and see, and take the hit on the profit margins,” he said. “What hit are they taking? Higher cost and anticipation of lower revenue due to demand destruction. So there's a group that's saying, ‘Wait and see, we know it’s going to impact profits, but we are willing to do that because we don't know how these tariffs are going to work out.’”
“Then there’s a second group that says, ‘We can't wait, we have to take action now,’” El-Erian said. “So you're starting to have soft freezes on hiring. You're starting to have rounds of… let's see what we can cut in terms of expenditure. And you're starting to talk about price increases, trying to pass on the higher cost to the end consumer.”
That second set of reactions, which makes sense at the level of each company, does not make sense for the economy as a whole, so it's going to be the balance between the two,” he added. “And I must say, that second set is larger. “From the people I talk to – of course, it is a small sample – but it's larger than the first set.”
Speaking on Friday morning immediately after the release of U.S. nonfarm payrolls, El-Erian emphasized the importance of the inflation data rather than the overall job numbers and said this would delay interest rate cuts.
“While I agree generally that this is not as relevant as it normally is as an employment report, I do focus on the 0.3% monthly earnings growth,” he said. “When people rush to predict lots of fed cuts, they forget the difference between what is necessary, and what is necessary and sufficient, weakness,” he said. “Pronounced weakness in the economy is necessary for the sorts of cuts that are being priced in, but they're not sufficient. The Fed needs some sort of air cover on inflation, and most forecasts of inflation are now going to 3% to 3.5% at the PCE core level.”
“The 0.3% monthly earning growth that we saw in today's report is not consistent with air cover on inflation, so this is a report that suggests to the Fed, ‘Wait and see.’”
El Erian has been one of the key voices sounding the alarm about the broader implications of the global gold rally. On March 19, he said in an interview with Bloomberg that the ongoing gold price rally represents a dire warning for the future position of the U.S. dollar in international markets.
“I think the gold issue is really important,” El-Erian said. “You've heard me argue here [that] people cannot escape the dollar as a reserve currency, but they can start slowly doing two things. One is building pipes around it, and two, changing the asset allocation to include a little bit of other things. And gold is one of the other things.”
“This should be flashing yellow in Washington here, that if gold continues to go up, regardless of all this, it's broken down all its historical correlations,” he added. “There's something going on about the dollar internationally, and that's something that they have to take really seriously.”
And on Oct. 21, El Erian penned an op-ed in the Financial Times arguing that Western countries should pay more attention to the rise in gold prices, as the precious metal’s persistent rally reflects increasing interest in alternatives to the dollar-based financial system.
“What is at stake here is not just the erosion of the dollar’s dominant role but also a gradual change in the operation of the global system,” he wrote. “No other currency or payment system is able and willing to displace the dollar at the core of the system, and there is a practical limit to reserve diversification. But an increasing number of little pipes are being built to go around this core; and a growing number of countries are interested and increasingly involved.”
El-Erian said that the current gold price rally is “not just unusual in terms of traditional economic and financial influences” but it also surpasses strict geopolitical influences to capture a broader phenomenon, which is building secular momentum.”
As these alternative pathways for international finance develop and grow, they could cause a fragmentation of the global system and an erosion of the power of the dollar and the U.S. financial system. “That would have an impact on the US’s ability to inform and influence outcomes, and undermine its national security,” he said.
“It is a phenomenon that Western governments should pay more attention to,” El-Erian concluded. “And it is one where there is still time to course-correct, though not as much as some would hope.”
