El-Erian Warns Markets Are Pricing In Too Many Fed Rate Hikes — ‘I Don’t Think We’re Going To Get Three’

During an interview with CNBC on Friday, El-Erian said investors are currently pricing in roughly two and a half rate hikes by the middle of next year and three by September.

• El-Erian argued that the market may be underestimating the economic consequences of higher interest rates, particularly in areas that are more sensitive to borrowing costs.
• He also pointed to the possibility that continued weakness in technology stocks could create a broader drag.
• El-Erian said investors are beginning to recognize that the AI trade depends on more than continued technological breakthroughs.

Markets may be expecting the Federal Reserve to raise interest rates more aggressively than the economy can ultimately withstand, according to Allianz Chief Economic Adviser Mohamed El-Erian.

During an interview with CNBC on Friday, El-Erian said investors are currently pricing in roughly two and a half rate hikes by the middle of next year and three by September. But he believes those expectations go too far, particularly as markets contend with weakness in interest-rate-sensitive parts of the economy and growing concerns around the AI trade.

Markets May Be Overpricing Fed Rate Hikes, Says El-Erian

El-Erian said markets have correctly assigned a relatively low probability to a rate hike at the Fed's October meeting, with the odds below 20%, while putting the probability of a December hike at nearly 90%.

"I think that's right. I think they capture well what is going to happen," El-Erian said of those market expectations. His bigger disagreement is with what investors expect after December.

According to the CME FedWatch tool, the odds of a 25 basis point rate hike in October stood at 15.5% at the time of writing.

"The market is pricing in total two and a half hikes by the middle of next year, three by September. I think that's too much," he said.

El-Erian argued that the market may be underestimating the economic consequences of higher interest rates, particularly in areas that are more sensitive to borrowing costs. He also pointed to the possibility that continued weakness in technology stocks could create a broader drag.

"I don't think we're going to get three hikes. But I understand why the market thinks we are," El-Erian said.

The comments come amid a stronger-than-expected inflation print. September's CPI rose 0.6% from the prior month, putting the annual rate at 3.7%, higher than the expected 3.6%, per a Dow Jones consensus estimate, according to MarketWatch.

El-Erian said the Fed cannot simply dismiss the recent inflation readings, even as the prospect of a near-term rate increase appears increasingly unlikely.

AI Sell-Off Could Spill Into The Broader Economy, El-Erian Warns

El-Erian also pushed back against the idea that weakness in technology stocks would simply trigger a rotation into other parts of the market.

He said investors are beginning to recognize that the AI trade depends on more than continued technological breakthroughs. Wider adoption and the ability to manage unintended consequences will also determine whether the investment boom can continue at its current pace.

"The AI trade depends not just on invention, which is going really well, but it also depends on broad dissemination, adoption and being able to risk mitigate the unintended consequences," El-Erian said.

Those factors, he argued, are not entirely within the control of technology companies. "The market has started to realize it's tougher," he said.

El-Erian also warned that a technology sell-off could have consequences well beyond technology stocks. Tech has attracted significant domestic and international capital, meaning a sustained decline could create both an economic and market-related effect.

"What I don't quite understand is the rotation trade that everybody is advocating what I call the one minus X. If tech does badly, that is going to impact non-tech for two reasons,” he said.

The first is the potential economic impact of weaker technology activity. The second is the market's dependence on technology stocks as a destination for investment flows. “So I do think that the non-tech side of the economy is vulnerable to the tech side,” El-Erian said.

He added that elevated Treasury yields, wider credit spreads and high oil prices could compound those pressures, potentially making it harder for the Fed to pursue the aggressive series of rate hikes currently priced into markets.

During the after-hours session on Friday, the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index, declined 0.26%; the Invesco QQQ Trust ETF (QQQ) edged lower by 0.27%; and the SPDR Dow Jones Industrial Average ETF Trust (DIA) fell 0.21%. Retail sentiment on Stocktwits toward the S&P 500 ETF was in the ‘bearish’ territory at the time of writing.

The iShares 20+ Year Treasury Bond ETF (TLT) gained 0.1% on Friday, while the iShares 7-10 Year Treasury Bond ETF (IEF) rose 0.08%.

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