The recent rise in consumer and investor sentiment could be short-lived unless the economic recovery shows signs that it's real, Pimco co-CEO Mohamed El-Erian said Wednesday.
A sharp gain in consumer confidence sent the markets soaring Tuesday on belief that the economy is showing signs of bottoming.
But El-Erian, speaking live on CNBC, said the government has to begin showing signs that it is ending its aggressive intervention policies. Troubling signs, such as a sharp rise in 10-year Treasury yields, threaten to end the high spirits that have lifted the markets off their March lows.
"People are worrying about potential inflation. They're starting to worry that the emergency liquidity is not going to be drained on a timely basis because of political issues," El-Erian said. "What the market is saying is this is a very delicate time and it's very important that it be navigated well by policy makers and investors."
Calling the current market climate "a challenging and interesting time," he nevertheless warned that confidence is a fragile thing and the current free-market system continues to be questioned by investors. El-Erian helps run the world's largest bond fund at Pimco.
"That model is being questioned and it's not clear what the substitute is," El-Erian said. "So there is a risk that you get a vacuum at the core of the system and you don't get anything to replace it. And that is why it's really critical the US bounce back quickly in a transparent and predictable manner."
At the same time, investors will need to see clear leadership from the market to believe a strong recovery can be sustained, El-Erian said.
"With the exception of a bounce in inventories, which we're going to get because inventories have really been run down, it's not clear yet what other component of demand can grow on a sustainable basis," said El-Erian.
"So the jump in consumer confidence is totally explained by the fact that the stock market rallied and by the fact that the stress test went well and that we were in a very oversold situation...So we've had a bounce," said El-Erian. "It's a cyclical bounce, but it's too early to say 'victory.' It's not clear to us what component of aggregate demand will carry the burden of strength going forward."