One Man’s Opinion: Have Markets Started To Believe Zero Interest Rate Is Normal?

92835431The latest US jobs report showing 257,000 nonfarm jobs being created in January has been extremely positive. It shows a higher participation rate along and less-sluggish wage growth, indicating a more inclusive recovery, said Mohammad El-Erian, former CEO of PIMCO and a Bloomberg View columnist.

The latest report showed wages grew 2.2 percent year-over-year while the month-over-month wage-growth was the best in six years. Asked to comment, Mohammad said growth in wages was certainly better but the economy needs to maintain the current pace of employment creation.

Many economists believed it’s just a matter of time before wages responded to the brisk pace of job-creation (3.1 million jobs were created last year), while there were others who wondered if stalled wage-growth indicated deeper structural issues. There’s no doubt the January reading is great, but the pace needs to be sustained going forward, he noted.

Asked if the US can pull out rest of the world from economic doldrums, Mohammad answered in the negative. The latest employment report shows the extent of economic divergence between the US on one hand and Europe and Japan on the other. It also underlines the divergence in monetary policies; it is likely to encourage the Federal Reserve to tweak its language in March and replace the “patient” word with a view that speaks about raising interest rates gradually this summer, he explained.

Asked if the jobs report changes Janet Yellen’s outlook for an interest rate lift-off, Mohammad answered in the affirmative. The report will encourage her because of its more inclusive nature and is likely to persuade the FOMC members to start making the first move this summer, he observed.

According to James Bullard – the President of St. Louis Federal Reserve Bank, zero interest-rate is inappropriate for the US because the economy is much-closer to normalcy than it has been for a long-time. Inflation is a little-bit low, but not low enough to rationalize a zero interest-rate policy.

Asked if he agreed with Bullard’s view, Mohammad said what Bullard said was being supported by a number of Fed officials, including Fed vice chair Stanley Fischer. They worry the markets have started to believe zero-percent interest rate is normal. Zero-rate is not normal – it encourages excessive risk taking.

The Fed officials want to raise interest rates at a slow rate and their intention is likely to get reflected in the next forward guidance report due March. The markets will adjust their expectations accordingly following Friday’s report, some of which got reflected in the repricing of certain asset classes, he noted.

Asked if events in Europe and Russia could slow-down US growth, Mohammad answered in affirmative. The Fed, in an unusual manner, spoke about major international risks going forward. Apart from geo-political risks in Ukraine, there’s political tension in Europe including the ongoing stand-off between Greece and Germany.

Investors need to keep an eye on US-Europe interest rate differentials and currency movements – that’ll indicate whether the widening divergence will be orderly or disorderly, he concluded.

You can watch the video here.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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