Mohamed El-Erian says don't cheer this rally as the Fed is still grappling with a 'trilemma'

Published Mon, Oct 24 20229:34 AM EDT

Mohamed El-Erian cautioned investors that this stock market rally is driven by the ever-changing expectations in Federal Reserve policy, and it shouldn't have lasting power. "What happened to our markets is ... we redefined what a pivot is. We redefined it from meaning lower rates to pausing, to slowing," El-Erian said Monday on CNBC's " Squawk Box ." "And if you redefine that, then you will have a liquidity effect. We are getting a liquidity effect rather than a fundamental effect." Markets widely expect the Fed to approve a fourth consecutive 0.75 percentage point interest rate hike in early November, but traders are now split on what happens in December. A Wall Street Journal report last week indicated some central bankers intend to discuss at the Nov. 1-2 meeting on how aggressive they need to be going forward on the pace of rate hikes. The shift in expectations partly triggered a big rally on Wall Street last week. The major averages had their biggest weekly gains since June, with the Dow Jones Industrial Average advancing 4.9%. The S & P 500 and Nasdaq rose 4.7% and 5.2%, respectively. El-Erian, Allianz and Gramercy advisor and president of Queens College, Cambridge, said the Fed is dealing with a "trilemma" — growth, inflation and financial stability, and it could be forced to slow down tightening for financial stability concerns. "Inflation hasn't turned around. Core CPI continues to go up. This is because of financial stability. This massive front-loading of rate hikes will break something in the financial markets," EL-Erian said. "So if the Fed does slow, it is because we have financial stability concerns." The widely watched strategist also said investors shouldn't take comfort in bond yields coming down around the world because they are moving lower on growth concerns. El-Erian believes the market might have overshot after last week's rally and investors should stay cautious. "If you are a technical investor, we probably overshot and you have some scope here," El-Erian said. "If you are a long-term investor, focus on the few names you know well and have a massive appetite for more mark-to-market risk."