Bill Gross on his expectations for QE3 and more
The following transcript and video is courtesy of Bloomberg TV where Bill Gross spoke to Margaret Brennan today, telling her that he thinks the Fed will go Qe3, but that it will shift to mortgage backed securities when Operation Twist ends in June.
There has been a lot of chatter about this of late and so it’s interesting to see what Gross has to say on the issue. For my part, I think the crux of the matter has to be that the Fed has really begun its third easing campaign. Now it’s not quantitative easing they are engaged in. It’s rate easing/permanent zero. Here’s how I put it in August:
I believe this is the first salvo in a renewed easing campaign by the Fed. I had been saying full-blown QE3 wouldn’t begin until 2012. In fact, the permanence of the zero to which the Fed has committed is much longer than I had anticipated. I would go so far as to call this full-blown rate easing, one of the three easing policies I identified earlier as QE3 contenders. That’s why you got three dissents at the last FOMC meeting, which you will almost never see at the Fed.
The 0.375% US Treasury note maturing on 31 July 2013 is now yielding only 19 basis points. Call this financial repression, call it rate easing, call it permanent zero or whatever you want; What the Fed has just done is effectively guarantee interest rates out to two years. In essence, QE3 has already started – and that’s bullish for fixed income investors because it guarantees a floor for non-credit-related fixed income investment risk. Interest-rate risk is gone for investments up to two years
Remember, the Fed has re-upped this by moving out the curve to three years. So people are really piling into the leveraged carry trade in the US, just like they are in Europe. Gross mentions in the video that Pimco has a relatively “firm” commitment to Treasuries because the Fed also has a “firm” commitment to zero rates. So the Fed has clearly had the intended effect in getting yields down.
As for what the Fed will do now, I think it’s very debateable. I like the way Tim Duy puts it, when talking about Bernanke’s speeches:
In my opinion, to interpret this as a call for additional quantitative easing is a bit of a stretch. It sounds like simply a confirmation that Bernanke believes the current policy stance is appropriate and that the existence of long-term unemployment should not be viewed as a reason to believe that we are closing in on a resource constraint that would necessitate a tightening of the policy stance.
In essence, Bernanke suggests that the recent rapid improvements in unemployment reflect largely a reversal of out-sized deterioration experienced during the recession. As such, we should not expect a slower pace of improvement given current growth forecasts. Under such conditions, I believe, Bernanke would push for another round of QE – although it stills begs the question of why he doesn’t push for more now given the existing forecasts. But he hasn’t, so we can only infer that he thinks the costs of additional easing outweigh the benefits.
He leaves open the possibility, however, that labor markets will continue to improve at the recent pace, in which I think QE3 is off the table. And that is where Federal Reserve President James Bullard steps in to the picture. He said pretty much the same thing in a CNBC interview
QE doesn’t work anyway. Let’s remember that loans create deposits. Having the Fed buy up Treasuries or even mortgage-backed securities and pumping the economy full of reserves, doesn’t increase lending. However, Bill is right when he suggests that the Fed buying up MBS could be a nice play for mortgage rates though. Recently, mortgage rates have backed up, just as we are approaching the summer selling season. If the Fed wants to support asset prices, then clearly, if the data weaken over the next couple of months, it would make sense for them to move on MBS instead of Treasuries as it would shift portfolio and lending preferences to MBS and the mortgage market.
That’s my piece. Here’s the video with Bill Gross and the transcript. He doesn’t limit his commentary to the Fed and QE3. There’s a lot more here. Enjoy.
"I think [Chairman Bernanke] is very satisfied…I think the Fed is outcomes-oriented. They want an outcome in terms of a higher stock market, in terms of housing starts and lower unemployment. What [Bernanke] said on Monday, in terms of the employment, he suggested that up until now, we’ve done very well in terms of reducing unemployment but it’ll be tougher going forward if only because of structural impediments that he outlined. Going forward, he’s looking at jobs, at unemployment and the housing markets. You know, future QEs will the outcome-oriented type of strategy which seeks to provide jobs and provide higher housing prices and housing starts to continue on."
On the tool that Gross thinks the Fed might deploy in April:
"I have a sense that they’ll continue with the Operation Twist, but not necessarily in terms of buying longer-term bonds and selling shorter dated Treasuries. I think that’s basically been played out and the pension market itself in terms of liability structure has been damaged to some extent by lower 30-year yields. I think [Bernanke] will try to do is Twist in the mortgage market. Basically, buy current coupon mortgages in agency spaces and then basically Twist by repo-ing out the Treasuries that they currently own in short-term space. So, you know, a twist on another Twist I suppose, going forward."
On the ticker change for PIMCO’s new ETF (to BOND):
"It is easy to recognize. I told my wife about it last night and in the middle of the night she started saying something about James. I hope she was referring to the ETF but you get the point… It’s more easily recognizable. In this business you want to go with a ticker and a sticker that people can recognize and pass on to their neighbors."
On Gross’s warnings to investors about management fees:
"We’ve noted that for a long time. This is simply a cautionary element that suggests that when interest rates come down close to zero and when the discounting of those interest rates and equity prices and other financial assets produce a perspective of 4-5% total return for the combined asset class is in our view, then it’s incumbent upon a manager to keep expenses low and to alert investors as to the importance of expenses relative to lower returns in this new financial world that we speak to."
On investor appetite for PIMCO’s new ETF:
"We wanted to be able to give investors a choice. We recognized the tremendous importance of the retail distribution network for PIMCO and for the Total Return Fund, which is now $253 billion. Thank you very much, we don’t to discourage that. But there are investors in the $10,000-$20,000 category, who find it difficult to buy PIMCO Total Return. We thought this would be a good way to do this in the actively managed ETF space. By the way, we’re outperforming the market in the first month or so by a good 200 basis points."
On PIMCO’s appetite for Treasuries:
"We have an average appetite in terms of duration space. And to the extent that five-year Treasuries, which are being issued today and seven-year Treasuries tomorrow – they reflect a relatively firm commitment on the part of PIMCO, which reflects a relatively firm commitment on the part of the Fed that they’ll keep interest rates firm until late 2014. Bernanke mentioned yesterday that that wasn’t a commitment in total but it’s subject to a relatively slow economy and contained inflation, which is what we see now. A five-year security at slightly above 1%, to our way of thinking, as it rolls down the yield curve and becomes a four-year, produces close to a 2% return and is that a super, deeper attractive type of return? Well it’s up to history. No, it’s not….but it’s certainly better than nothing."
"We have reduced our Treasury commitment slightly. From the standpoint of duration, we have average duration of an average maturity across the board but we have been reducing Treasuries and investing in shorter duration corporates and rather heavily in the agency mortgage market. You can get, with a Fanny or a Freddie coupon that is a 4% coupon, you can realize 3% as opposed to the 2% or 1% – I mentioned in terms of five-year space. We’re really focusing on spread and the lack of volatility going forward for the next two to three years which is really the domain of 30-year and 15-year mortgages."
On finding investing opportunities in developing countries:
"Where is that attractive growth? Countries like Brazil, countries in Asia, China-related of course. These countries don’t come without risk. They don’t come without a rather volatile situation in terms of inflation or potential currency disorder. If an equity investor is looking for growth, you want to go developing as opposed to developed. Even a bond investor, if you are looking for higher real rates such as in Brazil, you want to go to developing as opposed to developed."
On whether PIMCO will buy Russian five-year notes:
"We’re looking at the five-year, not the 10-year or the 30- year. At 230 basis points over the U.S. five-year, that’s an attractive situation. That doesn’t come without risks. It is a triple B+ type of security in terms of sovereign space and has a history of default going 10, 11, 12 years back. At these spreads and with situation currently, this is an attractive situation compared to U.S. Treasuries."
On buying hedges against fat tail possibilities:
"What we’re suggesting now is not an extremely negative possibility. That would be the fat left tail. But also the fat right tail, we’ve had a fat right tail in equity markets for the past 3-6 months…On the left-hand side, you know, the bi-model possibility in terms of a downturn are simply a reflection of the high degree of leverage, the high degree of debt and the policy coordination which may or may not be helpful in terms of producing this smooth, rather bell-shaped mode or median we’re all used to."
Source: Bloomberg Television