Economist and veteran bond watcher Mohamed El-Erian worries about a spike in borrowing costs, especially as the Japanese yen slumps and the Iran war heats up again.
Barron's spoke with El-Erian, the chief economic advisor at Allianz, on Friday about what he checks each morning instead of futures or Treasury prices, and why he is skeptical of an imminent Federal Reserve interest-rate hike.
He also has advice for investors in a shaky bond market. An edited and condensed version of the discussion follows.
Barron's: Bond markets are showing some strain. What worries you? El-Erian: People are only slowly starting to understand that in addition to massive bond issuances, reliable buyers [of U.S. debt] are no longer as reliable -- and in some cases have become issuers. The market is sorting that out by pushing yields higher.
We spent a lot of time analyzing the sources and uses of funds when I was younger, but people stopped doing so amid ample liquidity in recent years. That discipline is going to come back.
What does this analysis reveal? The Gulf, which was the most reliable provider of capital, is now increasing its bond issuances because they must fund domestic infrastructure as they rebuild and reconstruct from the war. Europe has massive military spending that requires more bond issuances.
Japan is another massive holder [of U.S. bonds] and has had its currency under pressure. Inflation is becoming a bigger issue and there's no agreement between the Central Bank, Ministry of Finance and the Prime Minister on raising interest rates or controlling the fiscal spending [to alleviate the currency pressure]. If they are forced to intervene because they can't agree to do anything else, they will be sellers of Treasuries.
And the message from Tesla and Google was very clear: They want to spend more. Google's negative cash flow quarter is consequential [for more bond issuances].
Does this backdrop have any parallels to past periods of trouble?
The global financial crisis was more an issue of payments and settlement system and tightening of liquidity because of overleverage. This is more a borrowing cost spike.
Stocks are barely off record highs. Why the disconnect?
Investors are in love with AI and what it can do for productivity; fiscal policy has been incredibly loose and there have been significant buffers -- like the cash on the sidelines and oil inventories.
What is the risk of the re-escalation in the war as some buffers are thinner?
We aren't in a good place. But the issue is if other factors that have helped [mitigate the fallout so far] are still there, such as the agility of the market to reroute oil, the U.S. becoming a major exporter of refined products and massive demand destruction from China.
The latest trade data show oil imports to China were down about 40% Part of that was from the drawdown of inventory, which is more durable than in the west because China started with much bigger inventories. The other is progress on electrification, which is durable.
If 15 million barrels a day were lost from the Strait of Hormuz disruption, we managed to compensate for five million and cut three million of demand, that leaves a 7-million-barrel gap. The [shipping through] the Red Sea takes out six million. If you think the Red Sea disruption is durable, then you must figure out how to offset that now. Goldman Sachs said oil could be $120 a barrel.
What does this mean for the Federal Reserve?
Core inflation hasn't moved. You aren't getting interest rate hikes in July. The market is pricing in a 70% to 80% probability of a hike in the fall. That's excessive. I don't think we will see spillovers [from the war] by then. If inflation is related to the AI buildout, quite a few Fed officials will be comfortable looking through it. July and August inflation numbers -- specifically core inflation -- will be important.
Given the risks you outlined, where should investors find ballast for their portfolios?
This has been the big dilemma. In 2022 when the Fed finally woke up to inflation not being transitory and went on an aggressive hiking cycle, you lost money in both stocks and bonds.
I would take some of the 40% bond allocation in a 60/40 portfolio and put it in short duration bonds -- 12 months to 18 months -- and keep rolling it over. You can do that with a short-duration bond fund, but I wouldn't take much credit risk.
Are you worried about the AI boom? It's great for the economy and wonderful for the U.S. to have capital markets able and willing to mobilize such funding. But I do think people underestimate that they should have more of a venture capital approach -- not every company will do well and therefore there are going to be losses. We have a "rational financing" bubble, not an economic bubble.
Many market crises hit in the low liquidity days of summer. What are you monitoring?
The Japanese yen, South Korea's KOSPI index and the 10-year U.K. yields because I'm less worried about financial stability risks in the U.S. and more in certain parts of the world.
Anything that forces Japan to sell U.S. securities like a massive intervention to support the yen or local funds' losses on Japanese Government bondholdings that requires them to repatriate foreign capital is a problem. On the economy side, what happens in Japan, stays in Japan, but on the finance side what could have stayed in Japan may not.
The same with the South Korea's benchmark KOSPI. It has spillover issues, and a lot of tech heavy funds have exposure to South Korean stocks. I look at U.K. bonds because the U.K. is strategically fragile. And it's high beta: If you tell me what the German yield is doing, I'll multiply it by two or three times and it will tell you about U.K. yields.
Thanks, Mohamed.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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July 25, 2026 02:00 ET (06:00 GMT)
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