EL-ERIAN: There’s 2 election scenarios that’ll cause the markets to go haywire

Mohamed El-ErianMohamed El-Erian, chief economic advisor for Allianz, speaks at the Reuters Global Investment Summit in New York, November 17, 2015.REUTERS/Brendan McDermid

Mohamed El-Erian is Allianz’s chief economic advisor.

We recently emailed him five questions for his thoughts on the market, the elections, and where stocks may be headed next.

Here we go:

Jonathan Garber: How many times will the Fed hike rates between now and the end of 2017?

Mohamed El-Erian: This is really hard to predict with sufficient confidence given the extent of global economic and financial fluidity. But if you force me to make a prediction, and if you disallow qualifications, my gut feeling says possibly three times – that is, once this year and two in 2017.

The driver for these hikes will be continued robustness in the labor market, slowly rising inflation and widening recognition that persistently low rates increase the risk of financial instability down the road. But the potential for hikes will also be limited by structural headwinds to growth, the associated decline in the neutral rate, and economic weakness abroad.

What is important to remember is that this cycle will be incredibly shallow, involve stop-go characteristics, and have a terminal value well below historical averages.

Garber: How do you think the election will impact markets?

El-Erian: The greatest impact would come from the materialization, as unlikely as this currently is, of one of the two tails – a clean sweep, with Democrats gaining control of both houses of Congress and of the White House; or, at the other end, Donald Trump winning the presidency and immediately moving to impose punishing trade tariffs on China and Mexico.

If either of these possibilities were to transpire, markets would experience the type of behavior that followed the Brexit referendum in June.

Apart from these two extremes, markets should be able to take the results of the election in stride.

Garber: Aside from the election, what’s the biggest risk to markets?

El-Erian: I would suggest monitoring carefully political events in Europe, particularly the Italian referendum this December and the German and French elections next year.

Garber: What is your outlook for US stocks through 2017?

El-Erian: I suspect that, in 2017, stocks will be a lot more volatile than they have been so far this year, especially as more improbables become reality and as central banks find it harder to repress financial volatility. This will also serve as a reminder of the extent to which traders and investors have under-estimated the potential for bouts of unsettling market illiquidity.

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