The so-called Trump rally in stocks is in "phase three," and investors better buckle up, noted economist told CNBC on Monday, arguing this is "overwhelmingly, a policy-driven" market.
"Phase one was a surge when people priced in the possibility of a changed paradigm for pro-growth policies" such as deregulation, tax cuts and infrastructure spending, the chief economic advisor at Allianz said on "Squawk Box."
In the first weeks of his presidency, Donald Trump has been aggressive in executive orders looking to roll back and evaluate regulations put in place by the previous administration of Barack Obama.
"I think we'll get some deregulation. But we need more than that to sustain the Trump rally," said El-Erian, former co-CEO at Pimco.
"Phase two was consolidation when we were waiting for the inauguration and the laggards did particularly well, tech being an example," he said.
"Phase three, that we're in right now, is volatility. And we're going to see a lot more volatility than we have for quite a while," El-Erian predicted.
With the Trump rally recently resuming after a mid-December pause, the Dow Jones industrial average and the S&P 500 were in striking distance again of record closes, as of the end of trading Friday's. The Nasdaq closed at a new high Friday.
Since Election Day, the Dow has surged nearly 9.5 percent based on Friday's close, while the S&P 500 has gained about 7.4 percent and the Nasdaq has jumped 9 percent.
A phase four of the stock rally depends on the execution of the promised pro-growth policies by the administration and the Republican-controlled Congress, El-Erian said.
"It would involve stronger markets if, in cooperation with Congress, the Trump administration were to move on the pro-growth elements of its economic approach," he said. "If it does not, risk assets would retrace some of the gains under the Trump rally, with a sharper retracement if the world were to also slip into trade wars."
Hours after Trump's inauguration on Jan. 20, El-Erian told CNBC it was clear the stock market was embracing the potential for the president's pro-growth policies. But at the time, he said Trump's "protectionist tendencies" were a concern for investors.
On interest rates, the internals of the government's better-than-expected January employment report on Friday "delays the Fed hikes," El-Erian said on "Squawk Box" on Monday. "So the probability of them moving in March goes down."
He cited in his argument disappointing wage growth and a pickup in the labor force participation rate, which suggests there are still gains to be made putting people back to work.
The market seems to agree, with the CME FedWatch Tool showing just an 8.9 percent chance of a Federal Reserve rate increase at its March meeting, with the probability going up as the year progresses.
At its December meeting, when the cost of borrowing money was raised for the second time in a decade, central bankers projected three moves in 2017.
Despite considering March as unlikely, El-Erian still sees three hikes for this year as the best bet.