Fed support is the reason why the market keeps rallying in 'rational bubble,' El-Erian says

Published Thu, Jan 7 20219:47 AM ESTUpdated Thu, Jan 7 20219:52 AM EST

A raging pandemic and political turmoil have not been able to sink the market, largely because those factors are outweighed by backing from the Federal Reserve and Congress, Mohamed El-Erian said Thursday. The Allianz chief economic advisor said the Fed's monetary stimulus along with the promise of still more spending on Capitol Hill outweigh factors that otherwise would drag down stocks and other investments. "There is so much liquidity sloshing around the system that it is finding an outlet in financial assets, and you're seeing this across the board, day after day, week after week," El-Erian said on CNBC's "Squawk Box" show. "So we will continue to have this contrast between what the market is doing and what conditions on the ground are telling you." As a mob supporting President Donald Trump stormed the Capitol Building on Wednesday, Wall Street was enjoying a powerful rally that took the Dow Jones Industrial Average to a record close. The move continued a bull market rally that began in late March as the Fed and Congress pledged a do-whatever-it-takes approach to seeing the economy through the Covid-19 crisis. While most of the nation was riveted on the events in Washington, the Fed released minutes from its December meeting showing that virtually all its members want to continue the bond-buying program responsible for much of that liquidity well into the future. When the time comes for the program to end, officials at the meeting said markets will get plenty of notice and the process will happen gradually. Consequently, the Fed actions, which mirror those from the European Central Bank and other counterparts around the globe, are enough to keep markets pushing aside headline risk. El-Erian said the situation could be considered a "rational bubble." "It's rational, because the Fed and the ECB keep on signaling that they will continue to inject massive liquidity, and as long as the market's so confident that that is the case, it will drive prices higher," he said. "So the market is saying, 'this is wonderful.' Central banks are pumping in liquidity, fiscal is going to pump in liquidity, and we know what is going to happen. Markets are going to go up," he said. Investors looking for clues as to when it will end should watch bond spreads, El-Erian advised. The difference in yields between the 2- and 10-year notes as well as the 2-year and 30-year bonds is widening, a sign that risk is increasing and that a contraction could be ahead. However, the timing of that is hard to figure now as the Fed remains accommodative and the election of Joe Biden to president with Democratic congressional majorities likely means significantly more stimulus is on the way.

The Allianz chief economic advisor said the Fed's monetary stimulus along with the promise of still more spending on Capitol Hill outweigh factors that otherwise would drag down stocks and other investments.