“There comes a point when no matter how much blood is being pumped through the system as it is now, with zero-based policy rates and global quantitative easing programs, that the blood itself may become anemic, oxygen-starved, or even leukemic, with white blood cells destroying more productive red cell counterparts,” Gross writes in his June investment outlook titledWounded Heart.
Gross believes that QE, which he describes akin to a bad dose of chemotherapy, will end later this year but not because of a suddenly strengthening economy.
Rather he thinks the Treasury will be forced to issue less debt because of lower than expected deficits, which would create a situation where there simply won’t be enough bonds for the Fed to buy to keep QE going.
Lower deficits mean fewer bonds available for purchase, and Gross doesn’t think the Fed would effectively destroy the Treasury market by maintaining its $85 billion-a-month bond buying spree.
“If the Treasury is only issuing a certain number of bonds it’s hard to believe the Fed would buy all of them,” Gross founder, co-CIO of PIMCO, and manager of the world’s largest bond fund, told Yahoo! Finance.
Why QE Hasn’t Worked
Ben Bernanke and other central banks are still betting that QE and similar economic policies will invigorate real growth. Unfortunately it’s looking less likely that’s the case.
“Central banks seem to believe that higher and higher asset prices produced necessarily by more and more QE check writing will inevitably stimulate real economic growth via the spillover wealth effect into consumption and real investment,” Gross said. “That theory requires challenge if only because it doesn’t seem to be working very well.”
His concern is that the historic injection of debt into the economy has ruined “carry” which he defines as the return over and above the fixed yield on an economy’s policy rate (fed funds).
For Gross, “carry” constitutes the beating heart of our financial markets and ultimately our real economy as well.
“Without the assumption of carry investors would be unwilling to risk financial capital and a capitalistic economy would die for lack of oxygen,” he warns. “More and more debt cannot cure a debt crisis unless it generates real growth.”
The 30-year Bond Bull Market is Over
Last month Gross said that the three-decade long bull market for bonds, including Treasuries, corporate debt and mortgages, most likely ended on April 29 with 10-year Treasury rates at 1.67%. Rates have risen over 33% since then to 2.23% –not a good sign for bondholders.
In fact, the Pimco Total Return Fund (MUTF:PTTAX), the world’s largest mutual fund, saw its first monthly withdrawal since 2011 amid a selloff in Treasuries, with clients removing $1.3 billion from the $285 billion fund.
Recent disclosures show that Pimco is actually selling bonds from the Total Return Fund.
In May the flagship fund lowered its Treasury holdings to 37% of its portfolio from 39% and also reduced its holdings of investment-grade credit, non-U.S. developed markets credit, emerging markets debt, and municipal debt.
We at Money Morning know investors want to know more about what to do when interest rates rise. That’s why our investment team will continue to provide analysis of how to maneuver in the fast-changing bond market.
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