Gross says Fed may cut rates by year's end

Bill Gross, one of the world's most influential bond investors and who oversees $445 billion in fixed income securities as chief investment officer at PIMCO , said at the Morningstar Inc. investment conference: "Central banks don't rest at one rate for long and if only to impart a bid to the U.S. housing market, they (the Federal Reserve) may have to start cutting again as early as the end of the year. I think the Fed will have to stop shortly. I know this differs from conventional wisdom which has the Fed stopping at around 3.75 percent."

In his most recent post to the PIMCO site he concluded, concerning long term rates:

The risk to bond markets going forward, therefore, will not be from having too much high quality duration, but too little. The demand for Treasuries should continue at high levels from foreign central banks due to the continuation of Bretton Woods II and from private global bond investors who will sense no threat from accelerating inflation over our secular 3-5 year timeframe. In addition, as our Secular Forum speaker Olivia Mitchell described, private and public sector pension fund changes are underway which will likely mandate increased allocations to long-term bonds in order to accommodate many nations’ demographic surge towards old age and retirement. The change is even further advanced in Euroland based on UK and Dutch pension accounting modifications. If we had to forecast (and we do), we believe a range of 3 - 4½% for 10-year nominal Treasuries will prevail during most of our secular timeframe and that yields on Euroland bonds will be slightly lower due to their structural unemployment problems, disinflationary incorporation of new Central and Eastern European countries into their existing family of nations, and more growth-inhibiting demographics. This bullish scenario is not without its risks, be they geopolitical, trade, oil, or internal budget popping related in the U.S. or Euroland. In addition, anything that threatens BWII or resembles a “helicopter money” monetary response described by Ben Bernanke could ultimately be bond market destructive.

Furthermore, the inherent leverage throughout the global financial system will pose a danger to risk-oriented markets (stocks, high yield debt, CDO structures, real estate) as owners gradually realize their returns can no longer be pumped anywhere near double-digit expectations. Whether this can be accomplished gradually as central bankers maintain or happen quickly as others believe is an important question, and points to the potential storm referred to in previous pages. We would suggest that although financial innovation and derivative products allow for diversification and a spreading of risk across more market players, the increased liquidity of our modern day system has also allowed for increased leverage, quicker exits, and therefore more systemic, system-wide risk. If institutional and retail investors in levered products become increasingly disenchanted with quarterly/annual returns, an unwind of levered structures could take place even in the face of continued economic growth, much like we’ve seen in recent weeks.

Categories: economy, interest rates, bond market, real estate