July’s march in the stock market was premature: Mohamed El-Erian

After suffering the first half of the year since 1970, the S&P 500 finished its best month in two years in July, but chief economist Mohamed El-Erian has yet to bottom out, suggesting that the recent rally is at odds with economic data.

“July was an example of the old saying that ‘the market is not the economy,'” El-Erian said in a Bloomberg article on Monday. Despite the 12% gain for the S&P 500 last month, El-Erian emphasized that the economy was showing no signs of improvement.

Consumer Price Index data hit a 41-year record of 9.1% in June, prompting the Federal Reserve to issue another strong interest rate hike last week as officials scramble to put out the inflation fire. Gross domestic product also declined for the second consecutive quarter, putting the US into a technical recession, even if it hasn’t been officially called out by the National Bureau of Economic Research.

The poor outlook extends beyond the United States. With energy shortages caused by Russian sanctions and rising inflation around the world, the International Monetary Fund said the outlook for the global economy looks “bleak and uncertain” – a warning that El-Erian says investors should take seriously even as markets rise.

“After I worked in [IMF] 15 years into my career, I can assure you that officials there do not take lightly with words such as ‘bleak’.”

Al Rayyan said the rally in stocks last week stemmed from an unwritten comment made by Federal Reserve Chair Jerome Powell at the press conference following the latest rate decision. Although the central bank admitted that it remains “very alert” to inflation, Powell said he believes inflation has reached the neutral level. This is the level of inflation where monetary policy is neither expansionary nor restrictive – in other words, indicating that the US central bank chief believes that prices have likely peaked.

That may have prompted investors to think that the Federal Reserve will soon ease tightening economic conditions, El-Erian said, bringing markets closer to what they enjoyed during the pandemic era of easy money and ultra-low interest rates.

“It should come as no surprise that markets are very sensitive to any hint of a return to the super-stimulus policy regime and ample liquidity. However, high and potentially sticky core inflation greatly limits the Fed’s ability to return to such system.” Al-Arian said.

Others criticized Powell for making the comment, including former Treasury Secretary Larry Summers, who called Powell’s statement “analytically indefensible” and “inexplicable” in an interview with Bloomberg.

El-Erian has been a vocal critic of the Fed for not taking control of inflation soon enough, and previously suggested that it would be difficult for the central bank to steer the US economy into a soft landing. He added that the future of the market depends to a large extent on the stability of inflation and the severity of the potential recession.

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