Mohamed A. El-Erian: Central Banks Can't Inflate Market Prices

English: Mohamed A. El-Erian, Managing Director of the Pacific Investment Management Company, (Photo credit: Wikipedia)

Atlanta, Oct. 13, stock investing .-  Some argue that the recent lackluster performance of global stocks is evidence that markets are tenuously positioned on an air pocket. We would put it differently. While markets have deviated quite a bit from economic fundamentals, this is due to central bank activism. Over the last few months, central bankers have re-inflated the wedge that separates weak fundamentals from high market prices. Whether it is the Fed’s open-ended QE3 and extended forward interest rate guidance, or the European Central Bank’s unlimited securities purchase program, robust asset markets are an integral part of policy attempts to counter tail risks and deliver economic growth and jobs. By artificially inflating asset prices above levels justified by sluggish fundamentals, these two central banks hope to calm market concerns, ignite animal spirits and trigger the wealth effect. And their actions are contagious. Whether they like it or not — and many don’t — other central banks continue to be pulled into more accommodating monetary policy. Witness this week’s round of interest rate cuts in Brazil and Korea as an example. These cuts did not happen because they constitute a first best policy. Rather, they seek to counter the collateral damage emanating from the unconventional policies pursued by Western central banks. That central banks are essentially “all in” is, in the short term, good news for all types of markets — especially when compared to the air pocket hypothesis. Yet, as I detailed in Thursday’s Financial Times , investors should not get too carried away. There is a limit to how far and how long prices can deviate from fundamentals. This is particularly the case when central banks, acting without the support of other government entities, do not have sufficiently-refined tools to secure good and sustainable economic outcomes. ... Continue to read.

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