Inflation is Tomorrow’s End-game

Friday, March 20th, 2009

There seems to be a fair amount of knee-jerk enthusiasm about inflation and inflationary assets, though according to some analysts, its too early in the offing to be taking a big stance in that direction. We’ve covered this off in many stories during the course of the year.

Everybody is reading from the same story book, but many of us are skipping to the end of the story, instead of fully appreciating the economic forces which have led to Fed’s decision to adopt quantitative easing, by adding a trillion dollars to its balance sheet. Bill Gross, PIMCO Managing Director, echoes that we will only see inflation as of 2010-2011. Here are some additional comments:

From Reuters:

Not all analysts agree the plan is a good idea or that it will cure what ails the heavily indebted economy, but many expect it to bring the benchmark 10-year note yield back down to the 50 year lows seen around 2.0 per cent seen last December.

“They can hold them down as low and as long as they want because they can print as much money as they want,” said Marty Mitchell head of government bond trading at Stifel Nicolaus in Baltimore.

“Yields can stay low and probably are headed lower.”

Inflation will ultimately become an issue, Mitchell said, but the more immediate concern was the prospect of a downward deflationary spiral in prices, wages and economic activity.

This means inflation is not on the agenda and will not be for at least a matter of months and possibly a couple of years.

“Inflation is tomorrow’s end game,” Mitchell added. “Right now they’re fighting off a deflationary environment.”

Mary-Ann Hurley, VP, Fixed Income Trading, D. A. Davidson says:

“While we’re not concerned about inflation right now, boy we potentially have a huge problem down the road. I don’t think it’s this year or next year’s problem but maybe 2011.”

“We’ve got a huge amount of stimulus and how is the Fed going to unwind all this? I can see a scenario where interest rates go up dramatically, which will hurt the economy. So, it’s a mess.”

Howard Simons, Bianco Research:

“We’ve crossed the Rubicon,” said Howard Simons, strategist at Bianco Research in Chicago. “We have absolutely severed any connection between our dollar and reality. It’s as fast as you can print it right now.”

The Feds decision is more likely at this stage to be bullish for bonds than for equities, as the rest of the developed world is forced to swallow the QE pill. There is also the age-old adage, “Don’t Fight the Fed.” If the Fed is buying bonds…for the time being in any case.

After all, how many of us really understand deflation?

Source: Reuters, Fed Plan May Lower Rates, But at What Cost?, March 19, 2009

Tags: Ails, Balance Sheet, Bill Gross, Bill Gross Pimco, Bond Trading, Deflationary Spiral, Downward Spiral, Echoes, Economic Activity, Economic Forces, End Game, Fixed Income Trading, Government Bond, Hurley, inflation, Lows, Managing Director, Marty Mitchell, Quantitative Easing, Reuters, Stimulus, Trillion, Vp, Wages
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Bill Gross: More Fed Buying Needed to Spur Growth

Friday, March 20th, 2009

Bloomberg: Pimco’s Gross says more Fed buying needed to spur growth
“Bill Gross, co-chief investment officer of Pacific Investment Management Co., talks with Bloomberg’s Kathleen Hays about the Federal Reserve’s plan to buy more than $1 trillion in Treasuries and mortgage-backed securities in an effort to help revive the economy.

Gross also discusses the Fed’s balance sheet, currency concerns and the need for a ‘healthy level’ of inflation.”

00:00 Fed’s buying: “We need more than that.”
01:16 Fed’s balance sheet; “buyer of last resort”
02:49 Treasury supply, currency concerns
03:54 “We need reflation. We need inflation.”
06:08 Strategy for TIPS; corporate bonds

Kathleen Hays: Yesterday, after this historic move by the Federal Reserve, you said, ‘Its not enough.’ We’ve heard from other economists who’ve said this could very well drive down that mortgage rate below 5% maybe to 4.5%, give housing a kick, give the economic recovery a kick, even by the second half. You don’t agree?

Bill Gross: No, I agree with all of that. Its just a question, Kathleen, of ‘how big of a kick?’ There are a number of ways of looking at this. Goldman Sachs has approached it from the standpoint of the Taylor Rule, the deficiencies of output relative to their own particular index.

We look at it a little bit differently at PIMCO, we look at it from the standpoint of the amount of debt that’s required to produce a dollar’s worth of GDP growth. And up until 12-18 months ago in terms of our existing economy, that was about $4 of debt for $1 of GDP growth.

This $1-trillion dollars to our way produces $250-billion of GDP; that’s just under two percent real growth. That`s good, that produces in our opinion about 1-million jobs, but we need more than that.

KH: Is it enough to avoid the mini-depression you were talking about last month when I joined you for an interview out there at Newport Beach?

BG: We think so, you know yesterday’s move by the Fed were in recognition of this recessionary economy that could have resembled a small depression unless credit markets and risk taking were revived. And in fact the Fed labelled their policies ‘credit easing’ and you mentioned the obvious intent to lower mortgage rates to homeowners and lower credit card rates, auto loans, commercial rates as well so, you know, its very much of a positive push. We have sense that the $1.8-trillion balance sheet that the Fed has, that’s now growing to $3-trillion, probably will have to grow to $5-trillion and $6-trillion in order to keep us on a trend line that produces positive as opposed to negative growth.

KH: So, you just think that they have to buy a lot more of all kinds of bonds?

BG: I think so, you know, that’s the way the Fed does it in terms of expell..uh expanding their balance sheet and ultimately yes that has been mortgages, its going to be treasuries and agencies. It may very well move into other particular asset classes if they’re well protected and triple-A rated. But, yes, certainly the Fed has to be the buyer of last resort here, because the Treasury is limited politically, and its limited from the standpoint of what’s been authorized in terms of their chequebook balance.

KH: Bill, do these Fed purchases, particularly of treasury bonds take supply in the government bond market off the table as the concern, what $98-billion of government bonds will be auctioned off next week, or does this huge scale of borrowing still pose some risk down the road.

BG: No I think it the supply off the table for the moment. What it introduces, Kathleen, however, is the problem of the currency, to the extent that the Fed is buying what isn’t desired by foreign holders, or by PIMCO. Then there are constraints, and there are problems that develop, in terms of the countries currencies. Basically if the Chinese or other foreign holders don’t want to buy treasuries, that’s a lack of support for the currency, and I think that’s what you’ve seen in the last several days. So nothing is perfect here; I think it helps with the supply, I think the Fed can keep interest rates where they want to keep them at least for 6-18 months period of time, but it will have consequences down the road.

KH: Consequences down the road in terms of inflation, in terms of a hard fall in the dollar, something you warned about in your letter this month?

BG: Well sure, inflation’s another one too. And, a declining dollar would directly lead into that. What the Treasury really wants to do, what the Fed really wants to do, what President Obama really wants to do is to create inflation, a positive level of reflation, that not only supports assets, but allows our nominal economy to grow at 4-5%. That is really what’s required in order to prevent debt destruction which means default, which means loss of jobs, which means loss of corporate health and welfare, so we need relation, we need inflation; hopefully much of that comes with real growth, but if it doesn’t then I think the Fed will take inflation.

KH: How does this play out Bill, if you see inflation coming back; i think actually one of the recent PIMCO report said ‘Inflation by 2010.’ That is kind of around the corner. How much lower can 10-year yields go, you’ve actually, your portfolio has more treasury bonds in it than it used to, more mortgage backed securities. When will you start turning that big ship, and again, the 10-year note yield, how low does it get?

BG: Well probably not that much lower, to be practical and realistic about this. I mean the Fed suggested they’re going to stay close to zero in terms of their policy rates for an extended period of time and that helps fives (5-year) and that helps tens (10-year), even outside of what the Fed’s doing in terms of purchasing power; it suggests that the carry is a positive going forward, but at some point probably late 2010 and beyond, you know, we will cross the line from deflation into inflation, and that doesn’t mean 3-4-5% inflation immediately, I mean there’s a huge output gap between capacity for people and capacity in terms of production. That’ll take a long time to close that so don’t too far in terms of what PIMCO’s forecasting, but what we really want down the road is a really healthy level of inflation to take us out of this debt deflation and debt destruction that we’re witnessing.

KH: So when you saw the news yesterday, I know you’ve been calling for the Fed to do something for a while, did PIMCO buy… what is your next step down the road? Again, what’s the exit strategy for PIMCO? The Fed’s supposed to have an exit strategy. What’s yours?

BG: We were well positioned, we’ve owned a lot of mortgages, and that $750-billion cheque for mortgages was very much a positive for the mortgage market, so that was a plus for us. You know what I think going forward is that, yes, if there’s going to be inflation in 2011, 2012, 2013, and if the government is going to be buying treasuries and TIPs by the way, and if the TIPS market is not going to see a significant increase in supply, which is what’s been announced at least up until this point, then the TIPS market is the way to go (as an exit strategy from deflation) and in the last 24 hours, you’ve seen a huge move in TIPS which is relative to nominal treasuries. Nominal treasuries went down by 30-34 basis points, TIPS have gone down even more, and up in price more, relative to their duration.

KH: How about corporate bonds, you said you should be at the top of the credit pyramid, you should be in corporate bonds and avoid equities and is there anything about the Feds program, very aggressive, historic, that makes you start shifting your view a little bit?

BG: Yes, I think to some extent, Kathleen, at least in terms of an attitude, maybe not in terms of a wallet or a cheque book, because we’ve had a lot of bank paper, and we’re comfortable there, in terms of what we own. There’s no doubt that if the Fed’s going to writing a cheque for a trillion dollars into the credit markets that that ultimately supports some asset classes further out on the risk spectrum. It doesn’t necessarily mean that stocks will do well, although, they’ve caught a bid so to speak since 24 hours ago, but it does mean that, yes, high quality coporate bonds are more well supported here.

KH: Okay, our thanks to PIMCO Managing Director, Bill Gross.

Tags: Bill Gross, Chief Investment Officer, Corporate Bonds, Economic Recovery, Federal Reserve, GDP Growth, Goldman Sachs, Gross Co, Hays, Investment Management, Kh, Last Resort, Mortgage Backed Securities, Newport Beach, Pacific Investment Management Co, PIMCO, S Gross, Standpoint, Taylor Rule, Treasuries
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Fed Employs Nuclear Option

Friday, March 20th, 2009

Financial markets were dominated this week by the announcement by Fed Chairman Ben Bernanke to buy as much as $300 billion of long-term Treasuries and acquire an additional $750 billion of mortgage-backed securities. On the news, the US dollar plunged, the euro surged, Treasury yields nose-dived, gold bullion exploded, and stocks, oil and commodities gained handsomely. What an announcement, what a week!

A few of the more interesting video clips that attracted my attention are shared below. In addition to Bill Gross stating that the Fed’s purchases are still not enough, AIG remained in the news as payment of bonuses to its executives from bailout money stirred up emotions. This culminated in the House passing a bill to tax TARP bonuses by 90%.

As far as the stock markets are concerned, with indices running into resistance levels the debate intensified on how enduring the recent gains will be.

The video clips feature the likes of Bill Gross, Steve Forbes, John Lonski, Mario Gabelli, Ron Paul, John Bogle, Barry Ritholtz, Doug Kass, Gary Shilling, Meredith Whitney, Marc Faber, Jim Rogers and Stephen Roach.

John Authers (Financial Times): Fed’s shock and awe
“John Authers on market reaction to the Federal Reserve’s decision to buy $300 billion in long-dated Treasury bonds.”

Click here for the article.

Source: John Authers, Financial Times, March 18, 2009.

Bloomberg: Pimco’s Gross says more Fed buying needed to spur growth
“Bill Gross, co-chief investment officer of Pacific Investment Management Co., talks with Bloomberg’s Kathleen Hays about the Federal Reserve’s plan to buy more than $1 trillion in Treasuries and mortgage-backed securities in an effort to help revive the economy. Gross also discusses the Fed’s balance sheet, currency concerns and the need for a ‘healthy level’ of inflation.”>

Source: Bloomberg, March 19 2009.

60 Minutes: The Chairman - Ben Bernanke
“In a rare interview with a sitting Fed chairman, Ben Bernanke tells Scott Pelley what went wrong with America’s financial system, how it caused the economic crisis, what the Fed is doing to help fix it and when he expects the recession to end. If you think your job is tough, consider Ben Bernanke’s. As Chairman of the Federal Reserve, the task of reviving the US economy falls largely on his shoulders.

In Part 2 of the interview Bernanke candidly speaks to Pelley about his personal life, and how the current financial crisis is affecting Main Street America.

Source: 60 Minutes, March 15, 2009.

Bloomberg: Geithner says US to move quickly on “legacy assets”
“US Treasury Secretary Timothy Geithner talks with Bloomberg’s Lizzie O’Leary about the US government’s plan to ‘move very quickly’ on impaired ‘legacy assets’ clogging bank balance sheets. Geithner also discusses planned action by the Group of 20 nations to end the global recession, executive compensation and US cooperation with China. They talk following a meeting of the G-20 finance ministers and central bankers today in Horsham, England.”

Source: Bloomberg, March 14, 2009.

CNBC: Forbes - Geithner, Bernanke have “the slows”
“Ben Bernanke and Tim Geithner both have a bad case of ‘the slows’, Steve Forbes, Chairman & CEO of Forbes, tells CNBC’s Martin Soong. Both of them have been slow to take decisive action on the banking crisis.”

Source: CNBC, March 20, 2009.

The Wall Street Journal: Sorting through the latest batch of economic data
“John Lonski, chief economist at Moody’s Capital Markets, interprets the latest economic data on housing starts and the producer price index. MarketWatch’s Kelsey Hubbard reports.”

Source: The Wall Street Journal, March 17, 2008.

Bloomberg: Mario Gabelli sees stability returning to US economy
“Mario Gabelli, chief executive officer of Gamco Investors, talks with Bloomberg’s Betty Liu about the outlook for the US economy. Gabelli, who oversees more than $20 billion in assets, also discusses American International Group’s decision to award some of its traders $165 million in bonuses.”

Source: Bloomberg, March 17, 2009.

Charlie Rose: A conversation with Nancy Pelosi, Speaker of the House

Source: Charlie Rose, March 13, 2009.

Charlie Rose: A conversation about AIG
“A conversation about AIG with Hank Greenberg former chairman and CEO of AIG, Carol Loomis Senior editor-at-large of ‘Fortune’, Gretchen Morgenson of ‘The New York Times’ and Meredith Whitney.”

Source: Charlie Rose, March 18, 2009.

Bloomberg: Ron Paul says AIG bonus money was stolen from taxpayers
“US Representative Ron Paul, a Texas Republican, talks with Bloomberg’s Carol Massar about American International Group paying $165 million in bonuses to its executives after accepting a $173 billion government bailout. Paul also discusses the role of the Federal Reserve and his recommendations for tax policy and spending.”

Source: Bloomberg, March 17 2009.

CNBC: Bonus tax - good or bad?
“Discussing House voting on bill to tax TARP bonuses at 90%, with CNBC’s John Harwood; David Min, Center for American Progress; Stephen Moore, WSJ; and CNBC’s Erin Burnett.”

Source: CNBC, March 19, 2009.

CNBC: Bogle-izing the hedge fund industry
“Thoughts on an investable index for the hedge fund industry with John Bogle, The Vanguard Group founder/former CEO. On the bonuses paid to AIGFP, Bogle says, ‘Off with their heads’.”

Source: CNBC, March 18, 2009.

The Street: Inside Bear Stearns collapse
“In an extended interview, William Cohen, author of the bestselling book House Of Cards, reveals the truth about what happened during Bear Stearns’ final days.”

Source: The Street, March 14, 2009.

Forbes: Barry Ritholtz on whether the stock market is near the bottom

Source: Forbes, March 16, 2009.

The Wall Street Journal: Trying to call an enduring bottom
“Trying to call an enduring bottom Barron’s Mike Santoli says the market has seen a 12% jump in a week while fewer stocks have made new lows, eliciting calls that we’ve finally seen an enduring bottom. Is this being too optimistic?”

Source: The Wall Street Journal, March 17, 2009.

CNBC: Kass & Shilling - has the bottom bottomed?
“Douglas Kass, of Seabreeze Partners; Gary Shilling, of A. Gary Shilling & Co.; and CNBC’s Larry Kudlow discuss today’s market action.”

Source: CNBC, March 18, 2009.

CNBC: Forbes - suspend mark-to-market accounting
“Mark-to-market accounting should be suspended says Steve Forbes, Chairman & CEO at Forbes. He tells CNBC’s Martin Soong the reasons why and how this has been a bipartisan disaster.”

Source: CNBC, March 20, 2009.

CNBC: Meredith Whitney - credit crunch & financials
“Weighing in on consumer credit and why mark-to-market will not really help banks, with Meredith Whitney, Meredith Whitney Advisory Group CEO.”

Source: CNBC, March 17, 2009.

Bloomberg: Rogers, Faber, Cheng on gold’s outlook
“Marc Faber and Jim Rogers talk about the outlook for gold prices and their investment strategies. Gold’s failure to rally to a record in recent weeks disappointed some investors, analysts said. Last month, the price climbed to $1,007.70, the highest this year. The all-time high of $1,033.90 was reached on this date last year. Schroders plc’s Christopher Wyke, Credit Suisse Group’s Tobias Merath and World Gold Council’s Albert Cheng also offer their views.”

Source: Bloomberg, March 18, 2009.

Financial Times: Oil price crash shifts balance of power
“Carola Hoyos reports from the Opec seminar in Vienna on how the collapse in oil prices has shifted the balance of power between oil producers and consumers and the companies within the sector.”

Source: Financial Times, March 18, 2009.

CNBC: Can China achieve its 8% growth target?
“China is dreaming, says Marc Faber, editor & publisher of The Gloom, Boom & Doom Report, when asked whether it can hit its 8% growth target. Faber & Jerry Lou, China strategist at Morgan Stanley assess the road ahead of China’s economy, with CNBC’s Martin Soong.”

Source: CNBC, March 17, 2009.

RGE Monitor: China now expected to grow 6.5% in 2009
“In a series of downward revisions, the World Bank is the latest to reduce its forecast of 2009 economic growth in China. As with many export-led economies, China has been hit hard by the precipitous decline in export demand, falling 25.7% in February 2009. For this reason, the World Bank reduced its 2009 growth forecast for China 1% to 6.5%.”

Source: Rebecca Wilder, RGE Monitor, March 18, 2009.

CNBC: Roach - China needs internal demand
“China needs to change its structure to an internal demand driven economy, says Stephen Roach, chairman for Asia at Morgan Stanley. He tells CNBC’s Martin Soong & Amanda Drury that China is hugely dependent on external demand as a major source of economic growth.”

Source: CNBC, March 18, 2009.

Financial Times: Bank of England pins hopes on quantitative easing
“Roger Brown, global head of rates research at UBS, says the Bank of England is in effect creating cash to kickstart lending in the UK. However, he tells FT’s David Oakley that the Bank must increase the amounts involved.”

Source: Roger Brown, Financial Times, March 13, 2009.

YouTube: Gold for bread - Zimbabwe
“MDC activist Sam Chakaipa returns to his village in Zimbabwe to find his friends and neighbours starving. As the Zimbabwean dollar becomes ever weaker, gold has become the currency of choice.”

Source: YouTube, March 9, 2009.

Tags: Barry Ritholtz, Chief Investment Officer, Doug Kass, ETF, Gary Shilling, Gold Bullion, Gross Co, Jim Rogers, John Authers, John Bogle, Marc Faber, Mario Gabelli, Meredith Whitney, Mortgage Backed Securities, Pacific Investment Management Co, Resistance Levels, Shock And Awe, Stephen Roach, Steve Forbes, Treasury Bonds, Treasury Yields
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