He saw few options to de-escalate tensions between Ukraine, its
Western supporters and Russia, which has been accused of backing an
insurgency led by ethnic Russian separatists.
In an interview at Reuters' New York headquarters on Monday, in
which he also spoke about his controversial departure from Pimco
earlier this year, El-Erian said just "one or at most two" more
rounds of sanctions and counter sanctions between Russia and the
West would likely push Europe into recession. That's especially true
if Russia cuts energy supplies during the coming winter heating
"I think markets are underestimating Ukraine," El-Erian said. "It is
very hard to find a solution that reconciles the three parties
involved – Ukraine, the West and Russia."
El-Erian said markets also were placing "enormous faith" in the
world's central banks, such as the U.S. Federal Reserve and the
European Central Bank. Through a series of experimental policy
actions since the 2008 financial crisis, the world's largest central
banks have gotten deeply into the "business of divorcing" asset
valuations from fundamentals.
The space between what El-Erian sees as lofty valuations and more
earthly fundamentals is "an air pocket" at risk of rapid collapse if
markets are confronted with a jarring catalyst, such as Ukraine.
"I worry that the marketplace is paying very little attention to
geopolitical issues, but they've done so for good reasons so far,"
he said. To date, investors have largely succeeded in navigating
numerous brief bouts of market choppiness in the face of
An endemic hazard arising from that is that investors want
unambiguous evidence that "the turn" has occurred before they opt
for a more defensive allocation, El-Erian said.
"The problem with that is that once you get that, everyone wants to
get out. And at that point, you get the air pocket."
A respected investor who once ran Harvard University's endowment,
El-Erian made waves in January when he resigned from Pimco, a unit
of German insurer Allianz and an investment powerhouse with nearly
$2 trillion of assets. There, he had been chief executive and had
shared the role of chief investment officer with bond market guru
The Standard & Poor's 500 Index and the Dow Jones industrial average
have both hit records in recent weeks, gains he contends are
emblematic of the disconnect between valuation and fundamentals.
[to top of second column]
Their performance is largely fueled by the Fed's actions, which have
made other assets such as bonds even pricier by comparison, as well
as financial maneuvering by corporations, which are spending cash
buying their own shares or on mergers and acquisitions, he said.
Stocks, he said, are signaling "We are expensive, but we are cheaper
than other things that are a lot more expensive."
El-Erian said Alibaba Group's record $29.7 billion initial public
offering last week is one reflection that markets continue to have
tremendous risk appetite because investors believe the Fed has their
That said, he believes the Fed is now out of sync with its peers,
the ECB in particular, and will begin to raise interest rates toward
the end of the second quarter of 2015, or sooner perhaps. Still, the
Fed will not be inclined to raise rates rapidly after that initial
"I think the Fed will move slower and not as high as we've been
historically used to," he said.
And, El-Erian said, if Europe goes in to recession, even the Fed's
projected lift off from near zero interest rates, where it has held
its policy rate since the end of 2008, would likely be off the
(Reporting By Jennifer Ablan and Dan Burns, editing by Peter
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