Tax Accord to Fuel Growth, Put Pressure on Bonds, El-Erian Says: Tom Keene

Pacific Investment Management Co.’s Mohamed El-Erian said that the U.S. tax agreement worked out by the Obama administration is good for growth as reflected in gains in stocks and commodities and declines in bonds.

“It puts pressure on the fiscal situation so bonds are selling off,” El-Erian, chief executive and co-chief investment officer of the firm that runs the world’s biggest bond fund, said in an interview on “Bloomberg Surveillance” with Tom Keene. “It is very important that the market is interpreting it as good for growth, so risk assets are rallying across the board.”

The yield on the 10-year note rose to 3.10 percent, the highest since July as President Barack Obama said he would agree to extend his predecessor’s tax cuts for two years. Stocks rose, sending the Standard & Poor’s 500 Index to a two-year high. Metals and energy producers rallied, sending gold and copper prices to all-time highs. Crude oil climbed above $90 a barrel to the highest price in 26 months.

President Obama agreed to accept lower rates on high earners’ income, dividends, capital gains and multimillion- dollar estates for the next two years to break a stalemate over extending the George W. Bush administration’s tax cuts for middle-class taxpayers before Congress adjourns. The current tax rates, enacted in 2001 and 2003, are set to increase Dec. 31.

‘Short of Expectations’

“We are opting for short-term stimulus in the hopes that we will get growth,” El-Erian said. “This is not a destination. This is a bridge. The last thing we need right now is gridlock in Washington. Up to this point, the Fed was being asked to do all the heavy lifting with imperfect instruments. The results of which is that policy effectiveness was falling short of expectations.”

The Federal Reserve announced following its Nov. 2-3 policy meeting the plan to buy an additional $600 billion in U.S. government debt through June to sustain the economic recovery and prevent deflation. In the Fed’s first round of asset purchases, which ended in March, the central bank bought $1.75 trillion in securities, including $300 billion in Treasuries.

El-Erian said that the tax compromise omitted a few key components to sustainable growth. “It’s not enough to boost demand,” he said. “You also need structural reforms to ensure that there’s a handoff to competitive high growth.”

‘Dependent on China’

The latest tax compromise will boost inflation in the medium term and the effects will also impact other economies, El-Erian said.

“People recognize the stimulus will leak out of the real economy into commodities, into other countries and therefore it will push inflation higher, including food inflation, which is a major problem in China,” he said. “With Europe having opted for austerity and likely to slow down even more, the global economy is very dependent on China both as a provider of growth and as a buyer of assets. If China slips, the outlook for the global economy would worsen significantly.”

Chinese inflation will accelerate past 4 percent in 2011, a three-year high, according to a Bloomberg survey. Gross domestic product will rise 9.2 percent in 2011, the median projection shows, compared with the 10 percent gain estimated by the World Bank for 2010.

Consumer prices in the U.S., excluding food and fuel increased 0.6 percent in October from a year earlier in the smallest gain in year-over-year figures going back to 1958, the Labor Department reported Nov. 17.

“There’s a limit to how much stimulus we can afford,” El- Erian said. “This is a temporary shift in the hopes you will trigger animal spirits that the cash that’s on the sidelines is put to work in terms of investments in equipment and in people.”

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Tom Keene in New York at tkeene@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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