[Editor’s note: the following is a cross post that originally appeared on CNBC.com]:
The dilemma facing the Federal Reserve is the same dilemma facing the NFL when it comes to replacement refs, Pimco CEO Mohammed El-Erian told CNBC’s “Closing Bell” on Tuesday.
“We know that the NFL refs are not first best, but we expect them to be perfect,” El-Erian said. “That’s the problem with the Fed. It doesn’t have the right tools. Expectations are too high and the Fed needs help from other government entities, but the other entities are on strike.”
Without politicians tackling the country’s fiscal problems, the Fed is likely to continue to provide extra stimulus and other extraordinary measures, El-Erian said, in hopes of provide a bridge until the politicians eventually step in and deal with the “fiscal cliff.” The fiscal cliff is when a host of tax cuts expire and automatic spending cuts kick in.
“If they don’t, the investment theme will go from betting on Fed liquidity to positioning for the collateral damage the Fed will create,” he warned.
Investors should also change their approach to the markets. The stock market has done well this year, with the S&P 500 up 15 percent, largely because central banks have removed the risks of U.S. recession and a breakup in Europe.
“If that tail risk comes bank in because politicians don’t sort out the fiscal cliff and European politicians can’t deliver on their policy commitments, then markets will come back down,” he said.
Protests in Spain and elsewhere are “an indication of how difficult it is to go from designing a response to implementing it,” El-Erian said. “Parts of the population are just fed up.”
While a return of these tail risks isn’t his base case, El-Erian said investing has become a differentiation story. “It’s no longer about betting on markets for removal the tail risks,” he said.
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© 2012 CNBC, Justin Menza. Front page photo courtesy the AP.