US Economy is Leaving Others Behind says Bond Prince El-Erian; this has Bullish Implications For the Dollar

Above: Mohamed El-Erian. Photograph by Stuart Isett/Fortune Most Powerful Women Summit, reproduced under CC licensing.

- USD likely to remain strong as the US economy unilaterally exits the 'new normal'

- Trump powerless over Fed policy which is unlikely to alter

- US growth high and employment strong leaving Fed able to raise rates

The Dollar's rally is probably not over yet, according to comments from legendary bond investor Muhamed A. El-Erian, the former CEO of Pimco and current chief economic adviser at Allianz SE, who is uncommonly bullish the US economy.

The US is an anomaly amongst developed market (DM) economies as it has managed the seemingly impossible feat of exiting the 'new normal' of relentlessly low growth, inflation and interest rates, says El- Erian.

"I think the US on a stand alone basis has exited the 'new normal'. Has found a higher growth equilibrium of 2.5 - 3 (%), a higher R-squared; the Fed can safely raise rates and you have a situation where more people can enter the labour force without increasing unemployment," says the Allianz adviser.

The US economy is on course for managing 2.5 - 3.0% real growth in 2018, and this is way beyond most of its DM peers.

"My central scenario is that we are somewhere between 2.5 and 3 as underlying growth rates, probably closer to 3; that is going to push up potential rates; that is going to bring more people into the labour force, so we are going to see labour participation going slowly up, and that is going to make the Fed worry less about low R-squared, and the neutral rate," says El-Erian in an interview with Bloomberg News.

This suggests out-performance by the Dollar compared to its G10 peers.

The main risk to the outlook for the US is now from outside.

"What we should be looking at is what are the external shocks to that process..from the outside not from within the US," says El-Erian.  

El-Erian is in favour of more not less 'sugar high' fiscal stimulus as it will allow the Fed to migrate rates higher, to a place from which it has scope to loosen if necessary when the next slowdown comes.

"More fiscal stimulus makes it easier for the Fed to normalise monetary policy," says the Allianz adviser.

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It's an Independent Fed and Not Trump's Fed

El-Erian thinks the Fed will ignore Donald Trump's recent criticisms of its policy path and continue raising interest rates regardless of what the President says because the Fed puts data first.

However, it will make communication extremely difficult for Fed Chairman Jerome Powell.

"Whatever they (the Fed) do there will be someone somewhere saying they were responding to Trump," says El-Erian.

If the Fed do not signal a September rate hike people will say they were responding to Trump; if they do raise rates they will say they are going out of their way to ignore Trump, adds El-Erian.

Trump this month attacked the Dollar's strength saying in an interview he is “not thrilled” by the Federal Reserve’s ongoing interest rate hikes which are providing the key underpinning to a stronger US Dollar.

"The United States should not be penalised because we are doing so well. Tightening now hurts all that we have done. The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due & we are raising rates - Really?" said Trump.

"The Fed will behave as if the tweets never happened," says El-Erian.

In the end, as an independent central bank, the Fed can act how it sees fit and in the history of the US it is rare to find any US President who has successfully swayed Fed policy.

"You have Presidents who have put enourmous pressure on the Fed: Johnson, Bush, and got nowhere; you have Nixon who put enourmous pressure on Arthur Burns, both explicit and implicit, leaks and all sorts of threats, and he got the Fed to loosen when it shouldn't have loosened and that contributed to financial instability," says El-Erian.

"I think that we have learned so much, and you have only to see what has happened in Turkey and Venezuela, to know you don't want to go anywhere near even the smell of the Fed being influenced politically that way," he concludes.

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