As we were just discussing, there is

perhaps an unusual difference of opinion

on whether the Federal Reserve is going

to raise rates or not this year. And

let's talk more about that. Joining me

in studio is Mohamed El-Erian, Allianz

chief economic advisor and professor at

the Wharton School. Always great to have

you, especially to have you in person.

Thanks for being here. Um

it does feel unusual how how divided

people are. I mean

you know, I just talked to a strategist

a few moments ago who said, "There's no

way that She said it's nuts that people

think the Fed is going to hike this

year." And then I talked yesterday to

Diane Swonk of KPMG who said, "Yes, they

have to hike this year." Um

is it is it because we are not getting

more of a framework from the Fed? Why is

there so much

arguing about this right now?

>> And it First, thanks for having me. And

it is amazing. Bank of England says Bank

Bank of America says three hikes.

>> Right.

>> Quite a few people say cuts.

>> Yeah.

>> I'm in the no change, so that you know

where I am. Um look, there there are

differences that relate to a few things.

One is how people interpret the

inflation numbers. So, last Yesterday we

had the PCE inflation viewed as the

Fed's favorite inflation measure.

You have those who said, "You know what?

In line to somewhat softer and will come

down. In fact, we may be at peak

inflation." You have those who said,

"Absolutely not. Look at core is going

to continue to go up."

Then you have the change at the Fed.

And people are wondering what that

change means. And then you have

different interpretation about the

economy. Some see it as extremely

strong. Others see it as strong in

certain places, but weak elsewhere. I

think if we put everything together, my

strong expectation, not weak, strong

expectation is the Fed does nothing this

year. And the most important thing to

focus on is the five areas that the new

Fed chair, Kevin Warsh, has identified

as needing work because they really

>> forces.

>> The task forces because they really do

need work. And the long-term

effectiveness of the Fed

will depend on addressing these issues,

which have translated into major

mistakes over the last 5 years.

>> But it also means we'll have to wait to

get more clarity. It sounded like from

what he was saying, it's going to take

at least till the end of the year until

those task forces really start to come

out with some findings from their work.

And so in

perhaps that supports your view that the

Fed doesn't do anything in the meantime,

but it also means the market has to sort

of keep wondering, right?

>> Yeah, and I think that what Kevin Warsh

is trying to do, and I think it's the

absolutely right thing, is break this

very unhealthy interdependency

that developed between the markets and

the Fed.

And it resulted in the Fed seeing its

room for maneuver reduced. That's not a

good thing.

And it resulted in in the markets being

very data-dependent, very short-term.

And we've seen significant changes in

expectations of of rates. I think

breaking that interdependency

is in the interest of the economy longer

term.

>> There's a lot of debate among other

things, and this is one of the things

that the task forces are going to

address,

how do we measure inflation? And there's

some talk about trimmed mean inflation

as one of the ways to measure it, but

there's a lot of debate about that

measure as well that it doesn't

anticipate sort of changes, regime

changes in inflation. Um, and so what is

the best way to then measure inflation?

How should the Fed be doing it? How

should we be doing it?

>> Yeah, I I'm not in favor of let's come

up with a whole host of inflation

numbers. I think there is a more basic

issue, which is the sources and uses of

data. What data we're actually looking

at. Is it concurrent data? Is it really

stale data or not? And the second issue

is is the monetary framework.

You know, very few people talk about the

fact that the 2020 framework was dead on

arrival cuz it was so backward-looking.

And the 2025 framework was never

completed. So,

this is a Fed that's going to be

revamped in a major way.

And I think that is more important than

whether they they keep rates unchanged,

cut, or hike. That is going to be

determined of where the economy goes and

where markets go.

>> Um

where does the balance sheet size fall

into the equation? Because there you

know, there's been talk that even okay,

maybe even if they don't change rates

that Walsh, as he has talked about

before, might try to shrink the balance

sheet.

>> My understanding is what he wants to do

is to have a theory underpinning balance

sheet management.

>> Before he does anything.

>> Anything. You know, whether you like it

or not, we talk about our star, some

sort of equilibrium interest rate.

No one has a clue

on the analytics of an equilibrium

balance sheet. And we've increased the

balance sheet from 2 trillion

to 9 trillion, back to 6 trillion. These

are massive moves.

Um and we we've done that without an

underlying theory of what the balance

sheet

should how should it should be managed.

I think it's striking if you look at the

Fed of the last 6 years, it went to

sleep, of course, on policy, making the

big mistake in 2021 calling inflation

transitory. It went to sleep on

forecast. It went to sleep on

compliance. We had five senior

officials.

It went to sleep on balance sheet

management.

And I think what you're seeing is a

major revamp of the Fed.

>> And it sounds like you think a necessary

one.

>> I think it's not just necessary, I think

it's been long delayed. We need We need

it urgently.

>> Um I want to turn to what's happening in

tech stocks recently. We've been talking

a lot about this. Um and and sort of

whether it is a bubble. Um

and if it even if it's not a bubble,

like what do we need to worry about when

we're looking at how how these things

have been trading?

>> So, the economist in me thinks it's the

most wonderful thing in the world that

the capital markets are willing to fund

innovation at the scale that they're

willing to fund it.

That makes the US unique in the global

economy.

The financial side of me says it is a

bubble, but it's a rational bubble.

In the sense that if you don't know

which of these platforms, which of these

applications

is going to prevail.

You have to have a venture capital

mindset.

You have to spread your bets

hoping that the one that works

pays

for all the

>> Enough to make up for the losses

elsewhere.

>> will because what's at stake is huge.

Which means that when when we're going

to look back and say

did we really invest that much in this

company?

Um I think more generally

we lived in a period where fundamentals,

valuations, and technicals were all

aligned for tech.

And we saw the most amazing run.

That put valuations out of whack. When

valuation got out of whack, technicals

got out out of whack and that's what

we're seeing today. It's technicals that

are undermining the tech trade.

Fundamentals remain sound.

>> Yeah.

>> So, I think this is more a temporary

setback than a permanent one and it

comes from the fact that the valuations

got completely out of whack.

>> How concerned are you about sort of

speculation and leverage in the system

right now?

>> So, I am worried about the leverage in

Asia.

>> Mhm.

>> You know, we don't talk about it there.

>> about this earlier in Korea in

particular.

>> Yeah, Korea and Japan. I mean, if you

look at what's been happening in those

markets this week.

>> Yeah.

>> Your worry. So,

the bad news is I think there's a ton of

leverage that is excessive. The good

news is that the spillover is going to

be limited to markets and not the

economy.

And that's really, really important. You

know, we're living in a world where

we concerned about markets.

But actually the economy for once

has lots and lots of tailwinds including

as someone spoke about in the recent

segment for the bottom part of the cake.

>> Mhm.

>> You have low energy prices.

You have a strong labor market.

You have lower borrowing costs. It's

really nice to have these headwinds turn

into tailwind for such an important

segment of the population. Um you know,

for a very long time the markets were

fine, the bottom bit of the economy

wasn't. It's good to see the bottom bit

of the economy doing well.

>> When we are so reliant though on

back to the economic front, we're very

reliant there on the AI build-out as

well. It's accounting for a much higher

percentage of of GDP than it was in the

past.

So, how worried are you about something

there going, you know, even in the

financial markets, yes, if you have

losses in one place you you can be made

up for by gains. But economically it

doesn't necessarily work that way. If

you've got a data center that you're

building and then the demand for that

data center drops, for example, you

know, do you have somebody else to come

and take it over? Does that just sit

vacant? Is do you have that sort of

economic um

you know, build-out that then goes bust

at some point?

>> So, I I think you have a short-term

issue and a long-term issue. The

short-term issue you captured perfectly

when you called it the knives.

The notion of an air pocket between

build-out and monetization.

The longer-term issue is every single

innovation

ends up overdoing it in the first phase.

And the behavioral aspects are very very

simple. When you suddenly reduce the

barriers to entry

to something that's really exciting, we

humans

overproduce it and overconsume it. It

happened in the Industrial Revolution.

It happened with railroads. It happened

with fiber optics.

>> Mhm.

>> Every single time that happens. So, yes,

are there going to be some data centers

that are going to not monetize the

investments? Yes, there are. But again,

I'd for the longer-term economic

well-being, I'd rather we overinvest in

it fundamentally transformational

innovation

than do what Europe is doing and under

invest. Because longer term, the over

investment the mistake of over

investment is much smaller than the

mistake of under investment.

>> And there's a concern now that because

of public resistance to the build-out

that we may be slowing down.

>> Yeah, I mean AI has a massive PR

problem.

>> Yeah.

>> Massive.

Okay, and they've they've got to realize

they're systemically important.

And they have to be out there with

stories. Google does it really well. It

says, "Look, I can change the health

sector.

I can change education sector.

Agriculture.

>> Mhm.

>> Farmers now can have in their hand a

tool that identifies much better whether

their crop has disease or not

>> Mhm.

>> and what the weather is like um going

forward.

You go to developing countries, it's

amazing that in rural Malawi, you can

have a clinic that now has access to

world-class medicine. You can have a

school where someone a student has a

personalized tutor.

I think AI need the AI industry needs to

tell these stories because the backlash

is starting to build up in a major way.

>> Yeah, and it will become material

potentially at some point.

>> Yeah, absolutely. And it's going to

become political as well.

>> Yes, definitely. Muhammad, thank you so

much. It's great to see you.