U.S. credit downgrade: Mohamed El-Erian says it's 'surprising'

Fitch has downgraded the U.S government's credit rating this is only the second time that has ever happened the first was back in 2011 that's when fellow credit rating agency s p cut this rating to the same level double A Plus Fitch now says its move reflects an erosion of governance which has manifested in repeated debt limit standoffs joining us now Muhammad Al Aryan Alliance allianz's chief economic advisor and Muhammad was formerly's CEO and co-chief investment officer at Pimco he's also the president of Queens College Cambridge it's great to talk to you as always Muhammad um you said in a tweet that you were puzzled certainly by the timing of this I wonder though if you are as puzzled by the fundamental case that Fitch is making here that there is so much dissent that this is really holding back the US from a fiscal perspective so the only response I would have to this is why now what Fitch put in their statement has been true for a while so why now and that explains the reaction that I and many others have had which is first this is surprising second when you look at the reasoning the reason you scratch your head as to the timing of this and then thirdly which is most important for our audience is the expectation that this will have minimal impact on the things that are sensitive to weightings in particular the credit default swaps the currency and and the yields so you know surprise but then expecting the market to brush it off which is exactly what has been happening this morning it has been happening to some extent but we are starting to see yields creep up a little bit more I saw a headline there at the highest now since November do you so again coming yes why now I I get that argument but how much of a problem is The Descent in the U.S and there's even been reporting that the team at Fitch was really spurred although again very late by the events of January 6th and sort of what that symbolized about what was happening in this country so January 6 is a long time ago yeah so to be spurred Now by something that happened um two years plus ago is a bit surprising look yields are going up for good reason and it started before the fixed announcement and it's continuing and the good reasons are twofold one is that consensus has Revisited the outlook for U.S growth and has become more bullish or less pessimistic about U.S growth we had another major announcement today that took recession out of their projections the Bank of America and then the second issue is I think people are starting to look at the inflation over the medium term and they're starting to realize that it's going to be really hard to maintain a two percent inflation average over the medium term that there are fundamental changes going on on the supply side that make it more likely that inflation will be higher than two percent uh Muhammad speaking of your tweets there was another tweet where you talked about looking at different variables to assess the impact of this and you know um why this was even necessary from bond yields to let's talk specifically about the dollar yes not much movement there but you also have some support from some economic news out today with regard to the dollar that's supportive there but what does this do to the dollar uh to you in your mind from your perspective for its status as the global Reserve currency yeah and that's the political side so the economic and the market side I think is is clear then there's the political side domestically and internationally domestically this is likely to fuel more of the polarized um conversations that are going on internationally for the adversaries of the US they will point to that as yet another development in terms of the US no longer being as powerful and as influential I think that those arguments are weak but it they will be used um by that I think it's interesting that the dollar the dxy index today is stronger rather than weaker if people were taking this Fitch downgrade as a serious um signal we would expect the dxy index to be weaker in fact it's back up above one or two as you know um earlier in the show we were sort of combining um The Fitch downgrade with the latest former president Trump indictment again as these signs of cultural and political dissent in the U.S as we head towards another election how much do investors need to pay attention to these issues so you need to pay attention to geopolitical and political risk factors um but then you have to make an assessment as to will they fundamentally influence the way the U.S economy behaves one of the big advantages of U.S economy relative to others is that the private sector is incredibly vibrant and tends to operate well on the different governance developments you know if we start taking governance into account then we're going to start worrying about a lot of countries because the US is not the only one to have a polarized conversation going on there's many other countries that are having difficulty forming governments forming stable governments um let alone um controlling their narratives Muhammad besides governance one of the things that Fitch cited in their decision was uh medium-term fiscal challenges namely the impact of the Aging population on expenditure programs so you know saying over the next decade higher interest rates and the rising death stop will increase the interest service burden due to an aging its aging population Rising health care costs CBO projecting that these interest costs will double by 2033 to 3.6 percent of GDP so given that kind of argument for it just I guess Playing devil's advocate with this question of why now but does this matter more than down the line so many of us have worried about the longer term fiscal implica fiscal Outlook and the need critically to promote High sustainable inclusive growth we don't have a debt problem as long as growth continues to pick up and one of the upside surprises has been not only that actual growth has picked up but the potential growth is starting to be positively impacted by policy and that's a really positive development that we haven't seen for a number of years so yes we should focus on the longer term debt issue the solution to that comes from economic growth and the need to revamp economic growth models most of the economic growth models in place today in the US in Europe in China are less potent and need to be revamped and that's what I would focus on and ironically again going back to the issue of timing this comes after better than expected U.S growth numbers and after people have revised up the outlook for economic growth so let's turn to your outlook for economic growth Muhammad are you in agreement here that things are fairly solid at the moment but not only that that we could indeed have a soft landing and avoid a recession with your current thinking on that so you know I've been consistent over the last year saying there is no reason for the U.S to fall into recession if you look at the U.S economy on on a standalone basis endogenously it is vibrant enough it is flexible enough and is handling this Global Soft batch well is there a whisk yes there is but it comes from another policy mistake my greatest worry is that the FED will over tighten that the FED will continue pursuing an inflation Target two percent that makes less sense for today's structural and supply side elements if we were to sit down and try to formulate what is the ideal inflation Target for the U.S economy I doubt that we would come up with two percent we'd come up with something closer to three percent it acknowledges the change in globalization it acknowledges the state of our labor market it acknowledges this changes in Supply chains and critically it acknowledges the energy transition the problem as you know is that it's very difficult for a central bank that has been missing its inflation Target to announce a change in its inflation Target so I understand why the FED doesn't want to talk about this but the only reason we would fall into recession after some massive geopolitical shock the only reason we'll fall into a recession is If the Fed is so focused on two percent and wants to deliver it quickly let it over tightens as you say Muhammad this has been your concern for quite some time we've been talking about it for a while the FED has been tightening all year the economy is going okay so what now does that policy mistake look like exactly in other words is another increase a policy mistake at its next meeting would it have to be further than that give us some sort of details around what that would look like so first as you know I wouldn't have hiked in July and I certainly wouldn't hike in September but then there's a more fundamental issue which is what I regard as excessive data dependency by the FED yes you want to look at the data but you don't want to be driven by backward looking data when your tool acts with long and variable lags okay so you have to have a strategic view of the economy as to where it's going and what where is it like you to settle down on that so I would critically start moving away from this excessive data dependence because my biggest fear Julie is by the end of the year headline inflation will start turning up again and at that point the FED if it continues to be excessively data dependent will be put in a really hard position and that's what we don't want that we want the FED to take the Long View to Target the medium-term inflation and make sure that we don't unnecessarily damage economic growth in response to short-term data uh Muhammad I want to ask you about the potential impact longer term impact I suppose to treasuries given the Fitch move does this create any kind of destruction of demand to say long-term treasury or short-term treasuries um not by itself um you know Diane one of the big questions is what do you replace the U.S treasury bonds with um a critical aspect as you know in financial markets is they often solve in relatives not absolute space people have to hold something and often people are very tempted to say this is no longer any good and then you say well what is it is it being replaced by you cannot replace something with nothing and so far there is no single other country that can replace the U.S in terms of Reserve currency and in terms of the most liquid Financial system so I don't think that this Fitch rating changes anything because if you were to apply the same criteria to other countries you would probably downgrade them as well and Fitch is going to have an issue now that it has put governance up front when asked well what about these countries that can't form governments what are you going to do with with them that is a great Point Muhammad finally to end it on a light note as we like to do just like there's no replacement for treasuries there's no replacement for the Jets in your heart as we know and uh full full disclosure full transparency I am not a big football fan myself but people on this team want to know if you think Aaron Rodgers is going to help the Jets win this year if we have a good offensive line he can help us break what has been a terrible record um for quite a while now but that's that's a big if um you know I'm you know me Julie I'm going to start like every other Jet fan with irrational hope only to have it replaced by crushing disappointment that that is what happens to our stress fan the fact that we remain loyal is a puzzle to many people well you know it's it's admirable I think Joanna are you a jet type too switch to the Giants Muhammad it'll be better I'm sorry they're both here come on switch just come on over I've been suffering since 1969. long suffering yeah be a bandwagon fan it's fine definitely there's free agents in the league come on over all right Muhammad alerian lifetime Jets fan I don't think there's any change now that's when they win it's so sweet aliant's chief economic advisor and president of Queens College Cambridge thank you great to see you Muhammad thank you

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Id: DPxTsZsnUls

Length: 14min 8sec (848 seconds)

Published: Thu Aug 03 2023