Double-dip recession risk rising: El-Erian

NEW YORK (Reuters) - The U.S. economy faces an increasing risk of stalled growth in 2010, the chief executive of top bond fund Pimco said on Friday, adding that rallies in the equity and bond markets have outpaced economic trends.

Despite signs that an economic recovery is taking shape, a soft job market and flat incomes could hinder a sustained recovery, Mohamed El-Erian, Pimco's CEO, told Reuters in an interview.

He spoke after the Labor Department reported that U.S. unemployment jumped to a 26-year high in August of 9.7 percent, although the pace of job losses slowed. Employers cut 216,000 jobs from payrolls in August, fewer than forecast, and down from a 276,000 drop in July.

"The risk of a double dip for U.S. economic growth in 2010 is increasing," with a 50 percent chance of such a scenario next year, said El-Erian, who oversees $850 billion in assets for Pacific Investment Management Co, known as Pimco.

"This challenges equity markets that are currently pricing a V-like recovery in corporate revenues and credit availability."

The summer rally in equity markets and lower-quality bonds has outpaced what is warranted on the basis of forward-looking indicators for demand, revenue, profits and credit flows, El-Erian said.

He said that rising demand in recent weeks for U.S. Treasuries, investors' favorite safe haven during periods of uncertainty, reflects the very weakness that he sees in the economy. "It is not that things are starting to improve, but that things are getting worse at a slower rate," El-Erian told Reuters TV.

U.S. stock markets began the first week of September in the red as major indexes dropped on Tuesday and Wednesday. In mid-day trade on Friday, the Standard & Poor's 500 rose 1 percent to stay above the key 1,000 level. The S&P is up about 48 percent from its 12-year closing low hit in early March.

JOBS KEY TO SOLID RECOVERY

Employment and wages are the key to a sustainable recovery. said El-Erian, especially because of the drying-up in credit. And Friday's payroll data confirmed that a transition from the economic boost from government stimulus programs and corporate needs to replenish inventories, to an increase in consumer and corporate demand is "far from assured."

"The unemployment rate is heading to 10 percent by the end of 2009 and, unfortunately, will stay at high levels for an unusually prolonged time," he said. "The implications of a stubbornly high unemployment rate go well beyond economics as there are also important political and social dimensions."

With a history of very flexible and responsive labor markets, the United States does not have sufficiently broad safety nets to deal well with high unemployment, El-Erian said.

He also cited lingering concerns about the banking system, with investors still nervous about the condition of regional banks in the United States and some European banks.

That's one factor behind a huge upward move in gold prices, which on Thursday hit its highest price since February at $997.20. Demand for gold is also being driven by inflation expectations, as well as tighter regulation on financial commodity-based products.

"We suspect the move in gold prices has reflected all three factors," El-Erian said. (Additional reporting by Daniel Burns; Editing by Leslie Adler)