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Bernanke's Four Challenges in Second Term: El-Erian

Federal Reserve Chairman Ben Bernanke faces a slew of challenges in his second term that will determine whether the US rebounds strongly from recession, Pimco's Mohamed El-Erian told CNBC.

Mohamed El-Erian, co-chief executive officer of Pacific Investment Management Co.
Photo: Oliver P. Quillia for CNBC.com
Mohamed El-Erian, co-chief executive officer of Pacific Investment Management Co.

El-Erian, co-CEO of the world's largest bond fund, broke the tasks for Bernanke, who was appointed Tuesday to a second four-year term, into four categories:

  1. Wind down the "unconventional policies" the Fed has used to rejuvenate the financial system.
  2. "Define the institutional integrity" of the Fed so as to reduce political involvement.
  3. "Revamp the operational components" of the Fed to ensure the bank takes into account changing asset prices.
  4. Regulatory reform, to make sure similar crises that rocked the financial markets for the past two years don't happen again.

"All of us as investors are going to have to keep an eye on the role of the Fed," Erl-Erian said in a live interview, using a sports analogy. "It's very different when the referee and certain government agencies have become both referees and players. It does make a difference for other investors."

Erl-Erian repeated his insistence that the stock market is on a "sugar high" that has pushed major indexes ahead of levels that underlying fundamentals would usually support.

The spree of stock buying has been pushed by the extraordinary government programs instituted by the Fed, and El-Erian said the key to recovery will be what happens when those policies are withdrawn.

While he said the Fed's efforts to drive down mortgage rates—generally through the buying of debt backed by Fannie Mae and Freddie Mac —likely would continue indefinitely, others will be taken off the table sooner.

He also suggested watching various economic indicators to see what the level of demand reflects. Wednesday's durable goods numberssuggested a pop in demand, but much of that was driven by the volatile transportation sector.

"What we're seeing here is the impact of the inventory cycle," he said. "It's not whether we're going to get a bounce on the inventory cycle—we will—it's whether we're going to get a handoff to final components of private demand. That's a huge question mark."

El-Erian also predicted a weaker dollar, which he said is necessary to stimulate demand for recovery.

"The issue is, does it do so in an orderly fashion, which is what everybody would want, or does it do it in a disorderly fashion?" he said. "I think if we don't get better international coordination the risk will be high."