El-Erian: These are 2 big market risks
The Federal Reserve is facing uncertainty between a healing U.S. economy and a weakening global economy, Allianz chief economic adviser Mohamed El-Erian told CNBC on Tuesday.
As a result, the Fed will likely start to raise initerest rates in the summer, but it will do so slowly, he predicted.
"They've got to build in some cushion. So I think they'll still go, but I think it reflects this divergence that's occurring in both economic performance and policy prospects," El-Erian said in a CNBC "Squawk Box" interview.
The current volatility in currency markets is a concern because history shows that sharp movements in foreign exchange result in something breaking somewhere in global markets, he added.
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"This has been the history over and over again. In the past it was emerging markets. This time it is corporations that are weaker, and importantly, it is adding to the volatility. And remember, the whole notion of the Fed is to repress market volatility," he said.
While currency movements are important, they are not unexpected, he said. Consequently, those movements will not change the Fed's calculus for rate hikes.
El-Erian sees two big risks in global markets this year.
The first is companies that are not hedged, particularly those that have a mismatch in revenues and liabilities. The number of unhedged companies in the United States pales in comparison to those in the emerging markets, he said.
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The second risk is the uncertainty over central banks' ability to repress volatility.
"They're battling. Look at the Russian central bank today. Look at the Swiss central bank today. They're having enormous difficulty dealing with foreign exchange volatility," he said.
Investors will have their resilience tested this year in the face of greater volatility as central bankers lose their ability to ease volatility, he said.
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The condition of the markets will be a geopolitical call as much as it is an economic and corporate call. Investors should keep an eye on Russia, which El-Erian said is a major source of concern for Europe.
"If Europe goes into recession, the U.S. is going to be impacted," he said.
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