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Mohamed El-Erian: Inverted yield curve recession signal is 'distorted' this time around

Key Points
  • "The bond market is distorted ... by what's happening outside the U.S.," says the Allianz chief economic advisor.
  • "If you live in an interconnected world, you have no choice but to import the effect of negative policy rates in Europe," he explains.
  • "That is going to distort our yield curve. And it's going to weaken the traditional signalling mechanism" for a U.S. recession, he argues.
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Allianz's El-Erian: Inverted yield curve recession signal distorted this time

Mohamed El-Erian, the well-known economist for Allianz who used to run investment giant Pimco, told CNBC on Thursday the inverted yield curve recession signal that made all the headlines this week might not be as reliable as it has been in the past.

"The bond market is distorted. It is distorted by what's happening outside the U.S.," said El-Erian on "Squawk Box." "If you live in an interconnected world, you have no choice but to import the effect of negative policy rates in Europe."

On Wednesday, the 10-year Treasury yield inverted, and briefly went lower than the 2-year yield for the first time since before the 2008 financial crisis and subsequent Great recession. Such a move has preceded every U.S. recession over the past 50 years, but a recession does not materialize on average for nearly two years.

El-Erian argued the U.S. should not have such low policy interest rates from the Federal Reserve or market rates in the bond market because the U.S. economic data are not pointing to a recession. But as he said Wednesday, the Fed has "no choice" but to cut rates again at its September policy meeting. Central bankers reduced rates at last month's gathering after hiking the cost of borrowing money four times in 2018.

"There are two realities," the chief economic advisor at Allianz explained on CNBC on Thursday.

The European Central Bank has negative rates and it's going to take them lower, he predicted.

"And it's going to restart QE," or quantitative easing, which is an accommodative measure that would involve the ECB buying government bonds from eurozone countries to further boost lending and stoke inflation.

"So all that is going to distort our yield curve. And it's going to weaken the traditional signalling mechanism" for a U.S. recession, El-Erian said.

In an interview Wednesday, former Fed Chair Janet Yellen made similar comments regarding the yield curve, saying traders and investors may be wrong this time around to trust it as a recession indicator.

"The reason for that is there are a number of factors other than market expectations about the future path of interest rates that are pushing down long-term yields," Yellen told Fox Business.

Yellen also said she does not think the U.S. is headed into a recession. "I think the U.S. economy has enough strength to avoid that, but the odds have clearly risen and they're higher than I'm frankly comfortable with."

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