Will more of the same last?
Last week served as an important reminder that the more things seem to change, the more they stay the same.
The first reminder came from the U.S. Federal Reserve when it removed the word “patient” from its forward guidance and opened the door for an interest-rate hike this summer. But it also accompanied this significant change with further “linguistic gymnastics” to counter any negative market reaction.
Chair Janet Yellen, for example, was quick to clarify that removing “patient” doesn’t mean that the Fed would become “impatient.” With that, markets were reassured that the Fed remains their best friend, resulting in impressive gains in equities and bonds.
Across the Atlantic, Greece and its European partners engaged in another round of a familiar dance: The country and its creditors agree to economic reforms that would unlock the billions of euros Greece needs to pay its bills and stop capital flight; the two sides then bicker over what was agreed to; and after trading old and new accusations, reconciliation talks resume.
The Fed and European officials seem to be following the same playbook - kicking the can down the road as they wait for more decisive actions. As insufficient as it is, maintaining the current equilibrium seems to be the best among a sub-optimal set of options.
The Fed is understandably keen on gradually normalizing its unconventional policy without causing too much market volatility and rapid declines in asset prices. If it can keep collateral damage low, the Fed can give the economic, financial and political systems more time to adjust and heal.
European officials are also keen to keep markets calm while they negotiate with Greece over the terms of another bailout. In the process, finance ministers and the European Central Bank hope to minimize policy mistakes and market accidents that could risk Greece exiting the euro club.
The problem for both the Fed and Europe is that it’s becoming trickier than ever to buy time, rather than decisively solve problems.
The Fed’s continued effectiveness could be challenged by the tug-of-war between asset prices that are moving ever higher - possibly beyond what the improving fundamentals would justify - and the effect of monetary policy that is gradually tightening. These opposing forces have led to see-saw sessions in financial markets.
Meanwhile, the endless wash-rinse-repeat cycle between Europe and Greece is eroding the credibility of governments. It’s also fueling the emergence of non-traditional parties throughout the region.
One should never confuse the willingness to maintain a tentative equilibrium with the ability to deliver more lasting and positive monetary- and economic-policy results. As they seek to pivot to better and more-sustainable situations, Europe and the United States would be well-advised to remember that their partial responses - as much as they are welcomed by markets for now - are simply buying time rather than guaranteeing desired outcomes.
by Mohamed El-Erian, The author is the chief economic adviser at Allianz SE.