Bill Gross: More Fed Buying Needed to Spur Growth
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March 20th, 2009 by AdvisorAnalyst
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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.
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