Top Economist Sounds Recession Alarms and Warns of Stagflation After Bank Failures

Mohamed El-Erian, chief economic adviser of Allianz, at FOX Studios in New York, on April 29, 2016. Rob Kim/Getty Images

Noted economist Mohamed El-Erian said the U.S. economy is facing higher odds of a recession and stagflation after a series of high-profile bank collapses last month.

“The flashing red light resulting from a speed-of-light run on the U.S. banking system, or what economists broadly refer to as financial contagion, is behind us,” the longtime economist wrote in the Financial Times Monday. “Yet it is too early for policymakers to declare mission accomplished.”

With the recent collapses, the banking system will be more cautious to issue credit, he warned. Meanwhile, Americans reportedly have moved away from bank deposits and are placing their money in market funds which offer higher yields as the Federal Reserve continues to raise interest rates.

“Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation,” he wrote.

“All this leads to the uncomfortable finding that we are on the cusp of a credit contraction that will play out over the next several quarters, probably reaching its apex towards the end of this year or the beginning of next year,” El-Erian, the chief financial adviser at Allianz, wrote for the Financial Times. “It is a phenomenon that, unlike financial contagion, is not easily countered by policies.”

But El-Erian told CNBC on Monday that the U.S. economy can avoid a recession as long there’s a “Fed policy mistake,” and made note of last week’s data showing that there is a higher labor force participation and payroll growth.

The data show that U.S. employers maintained a strong pace of hiring in March, pushing the unemployment rate back down to 3.5 percent and signaling labor market resilience that will keep the Federal Reserve on track to raise interest rates again. Labor-market tightness is drawing more people into the workforce, with 480,000 entrants last month, which could help to further restrain wage growth.

Nonfarm payrolls increased by 236,000 jobs last month, the survey of establishments showed. Data for February were revised higher to show 326,000 jobs added instead of the previously reported 311,000. Job growth averaged 345,000 per month in the first quarter, more than triple the pace needed to keep up with growth in the working-age population.

“There was certainly nothing in today’s report to raise concerns about near-term recession risks,” Michael Feroli, chief U.S. economist at JPMorgan in New York, told Reuters on April 7. “We continue to look for a 25 basis-point hike at the May meeting, followed by an extended pause. We see some risk of another hike in June.”

Financial markets are leaning toward the central bank increasing rates by another 25 basis points at the policy-setting meeting of the Federal Open Market Committee on May 2–3, according to CME Group’s FedWatch tool, Reuters reported.

Other Warnings

During an interview with The Wall Street Journal on Monday, billionaire hedge fund proprietor Paul Singer warned investors that recession risks are continuing to escalate. Singer noted that the American economy is currently in an “extraordinarily dangerous and confusion period.”

“Valuations are still very high. There’s a significant chance of recession,” Singer said. “We see the possibility of a lengthy period of low returns in financial assets, low returns in real estate, corporate profits, unemployment rates higher than exist now, and lots of inflation in the next round.”

Former Treasury secretary Larry Summers, currently a Harvard University professor and paid contributor to Bloomberg Television, told Bloomberg late last week, “We’re getting a sense that there is some substantial amount of constriction in credit,” which means that “recession probabilities are going up at this point. And I think the Fed’s got very, very difficult decisions ahead of it---with very much two-sided risk.”

Reuters contributed to this report.