Yesterday morning PIMCO’s Bill Gross wrote on Twitter that the “Fed will never sell what they now own but will stop buying more @ some point. Question is when? Growth dependent. We est. Jan 2014.” Gross also told Bloomberg Television yesterday that quantitative easing would continue through “at least the end of the year.” This is important given the relative hawkishness that people took away from the Fed’s January FOMC minutes.
Fed watchers like University of Oregon’s Tim Duy believe the January minutes show the Fed wavering on its commitment to QE and he believes this would imply an equally less-committed stance to low rates, if true. My view is that the Fed has always had doubts about QE, first because it has only been known to be effective in raising asset prices and has not had unequivocal results on interest rates, employment, or the real economy. Moreover, there is considerable political pressure on the Fed to adopt a more hawkish stance in order to fight inflation.
Lastly, many Fed officials, especially regional Fed presidents, are rightly concerned that low interest rates and quantitative easing – aka loose and easy money – will have a negative impact on credit quality that leads to increased loan losses when the credit cycle turns down. Despite unease with QE and zero rates, Fed officials feel they have no choice but to adopt the policies they are adopting given the weak economy, relatively tight fiscal policy and the Fed’s dual mandate. I don’t believe the Fed should be using QE and zero rates as a tool to drive maximum employment because I don’t believe that is the domain of a central bank. Easy money will have unintended consequences. But, how else could a monetary agent support maximum employment in this economic environment?
As for Bill Gross, he also said that the Federal Reserve knows that its easy money policies have a negative impact: “There are ultimately and presently negatives to these policies. The chairman recognizes that.”
Below is the video and a partial transcript of Gross’ Bloomberg Television interview.
Source: Bloomberg Television
Gross on whether this is the end of quantitative easing as we know it:
“Not yet. As my tweet indicated, I think it’s growth dependent and what type of growth would be necessary to and quantitative easing? Probably something like 3 to 3.5% for a number of quarters and probably something approaching 7%, given the 6.5% unemployment rate. We don’t think we are there yet. Obviously yesterday the minutes raised the possibility. There is dissension amongst the participants, the governors, so to speak, but the three primary musketeers, the three musketeers, we call them — Bernanke, Yellen and Dudley — are in firm command and we don’t think anything is going to happen for at least 10 months.”
On whether 3.5% growth will happen in the near future:
“It would feel like it is coming if we did not have fiscal austerity and the pullback in terms of government spending or the potential pullback. Housing and other house related industries are pulling the economy forward, but only probably only at a 2% pace. The Fed has indicated–not for the purposes of quantitative easing specifically–but in terms of their policy rate, raising that 25 basis point policy rate, that they would need at least 6.5% unemployment and perhaps 2.5% or higher inflation for one to two years. We’re close to those so quantitative easing, in terms of a trillion dollar package, $85 billion monthly package of treasuries and mortgages, we think it continues until at least the end of the year.”
On how to get out of the quantitative easing scenario that we’ve been in for so long:
“That’s very difficult, not just for the Fed, but other for other central banks. at the moment, the bank of japan is about to enter the pool, so to speak, the deep end. The Bank of England as well, perhaps, with carney indicating as much. Is it easy to get out of the deep end once you get into it? It gets difficult, because the market begins expects a constant infusion of liquidity–$85 billion a month into the bond market, which extends out into high-yield and equity credit as we move forward. Once you cut off the check writing and the purse strings, it becomes a problematic question in terms of valuation and the ability of markets, stocks, and bonds to continue on.”
On his tweet on 2/20 saying that bond vigilantes are no more and central bankers are the masters of the universe:
“They are trying to let us know that they are vigilant. We saw the minutes yesterday and they were extensive and they meet every other month or more frequently. Are they vigilant? They are in terms of their objectives. what the fed is trying to do is reflate the economy, that means not only produce 2 to 3 to 4% real growth, but a modicum of inflation in combination such so we have a nominal 5% of GDP environment. Are they vigilant in terms of moving towards that goal? Yes. Will they be vigilant in terms of having reached it then pulling back and not disrupting markets? Perhaps not. We’ll have to see going forward.”
On whether central bankers have been irresponsible:
“I would say this and Bernanke said it as well, that there are negative aspects to these policies. The negative aspects come in various forms, potentially with narrow credit spreads and higher risk in terms of asset prices. They come in terms of market making and liquidity aspects of the market itself, they come, as I have indicated and PIMCO has tried to advance in terms of an argument that low interest rates are a negative influence in terms of savings and therefore eventual investments. There are ultimately and presently negatives to these policies. The chairman recognizes that but what he does recognize going forward is if he can reflate the economy successfully, most of those troubles will go away. We remain able bit skeptical,, but we’re just going to have to see.”
On why he tweets:
“It doesn’t take very long. I take my cup of coffee, one or two cups, and get my brain working, and then something comes to mind that listeners might take advantage of or be respectful of. Do I tweet what is exactly on my mind? In some cases because of the 140 letter limit, it’s hard to get across the message. But yes, I enjoy tweeting.”
On writing that each additional dollar of credit seems to create less and less heat:
“Credit has been expanding for a long time, certainly since 1971 when Nixon abandoned the gold standard. During that period of time, credit, which includes corporate bonds and household debt, etc., has expanded from $3 trillion to $56 trillion over that period of time. Less and less bang for that $56 trillion? Certainly, because during that process credit spreads have narrowed and interest rates have come down. The process of real growth generation from credit expansion is almost necessarily come down as well. It is the same thing as saying that corporations are less willing to invest in a real economy that returns lower and lower rates of return than they were back in the 70’s, in which credit was less available. As spreads compress and interest rates come down, you almost necessarily have a credit market that is less effective.”
On whether we should be concerned about this:
“I think we should. At some point, the ability of capitalism to expand on the basis of credit expansion is limited. Certainly capitalism is correlated specifically to productivity and growth in the labor force. That combination depends upon credit and successful productivity of credit itself in terms of its expansion and ability to fertilize in terms of real growth. Going forward, we should be concerned about that. Robert Gordon and others suggesting that all of the low hanging fruit has been picked–in this case in terms of credit. much of the gain from credit expansion has already been realized. We have got to look for other avenues in terms of real growth going forward.”
On the so-called currency wars:
“We don’t necessarily think it is a war in terms of firing bullets across borders. Each country is operating for its own benefit. It happened in the 1930s in terms of competitive devaluations. They did not call it currency wars back then. These days, the currency wars are basically fought with quantitative easing and check writing and lower and lower policy rates. Is it a war? Perhaps there is competition between countries in terms of this race to the bottom, this willingness or proclivity to lower their currency so that their exports and real growth will be higher than other particular countries. There is nothing wrong with that. The question you ask, is a dangerous? It is, relative to inflation. Each country–the bank of the japan, the UK, the US–to the extent that they are all writing checks, basically what they’re doing is inflating and trying to reflate their economies. That is a danger for the bond market to the extent that inflation moves from 2% to 3% over the next few years. It’s a danger of fixed income investments relative to real assets to gold and depreciation of the currency itself.”
On whether a gold standard could be enacted:
“There are those on the right or left extremes that suggest that we should have some type of rock or foundation in terms of our ability and banks’ ability to generate credit. I think that probably is true. But whether or not the country or the global economy can move back to a gold standard, per se, that would be very difficult. What central banks need to do is to maintain a semblance of conservative check writing. A trillion dollars a year in terms of quantitative easing, that to me and to the market is not conservative. It helps to elevate asset prices and to lower interest rates, but in the long run it is basically inflationary in terms of its momentum. So gold standard? Let’s think about a central bank standard–about central banks becoming vigilantes again and then we will talk about gold at some future date.”