Bill Gross: QE on hold but QE3 would be back on if jobs reports are weak
Last month PIMCO founder and Chief Investment Officer Bill Gross said PIMCO sees a mortgage-backed QE3 from the Fed as likely. As a result, Pimco has increased its exposure to these. He spoke to Bloomberg television yesterday about how his views on this have changed.
The Fed has really begun its third easing campaign. It’s not quantitative easing but rate easing/permanent zero they are engaged in. It started out as a 2-year trade, then the Fed has re-upped this by moving out the curve to three years. How could the Fed do more if the economy weakens? That’s what everyone is asking. QE itself has no real economy effects and works only through communicating a commitment to lower rates, shifting private portfolio preferences. If the Fed really wants to support the economy 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. Mind you, 30-year rates are already at 3.7% so I am not sure how much more the Fed can do. But that’s what we’re talking about here.
Below is the Gross interview and partial transcript. Gross says he now doubts whether we will see another round of quantitative easing in June, but that "if we see some weak employment reports over the next two months, then QE3 is back on." He also said that there’s a risk of a double-dip recession “if liquidity disappears.”
Source: Bloomberg Television
Gross on whether he’s betting on another round of quantitative easing:
"I don’t at the moment. I am willing to listen and I did listen intently at the press conference and to prior speeches from Janet Yellin and Mr. Dudley in New York. The big three at the Fed I think have moved closer to the middle in terms of the need for additional QE. They in the market are going to wait for the next eight weeks for two key employment Friday reports between now and then, as well as tomorrow’s GDP number, which I think should be judged in my opinion by nominal growth as opposed to real growth. The Fed does not target nominal GDP. They target inflation though. They want lower unemployment, which requires 3% real growth. So the 2 plus the 3 equals a 5% nominal GDP growth target, which the Fed really wants to shoot for. So watch tomorrow’s numbers and don’t be dissuaded by the 2.5% number or the 3% real growth number. It’s the nominal growth number that is key."
On whether the Federal Reserve will resist an additional round of quantitative easing:
"I think so. The Fed does want unemployment to come down. It has been coming down. As a matter of fact, it’s lower than their prior projections were. There’s little doubt in my mind that a target for unemployment of at least 7% and perhaps lower is what they’re shooting for and that is going to require, 6, 12, 18 months, in my view. It might and probably will require, maybe not on June 30, additional quantitative easing. Quantitative easing is basically writing checks. The Fed’s been writing checks, the ECB has been writing checks, the Bank of England has been writing checks, even the Bank of Japan has been writing checks. This is $2-3-4 trillion worth of check writing that has supported financial markets, but in turn has allowed for employment growth and lower unemployment. I really think that it’s required. I don’t welcome it from the standpoint of the negative consequences, but I think it is required."
On whether he would rule out QE3 down the road:
"I don’t think so. The Chairman has not ruled it out. Again, to reaffirm, if we see some weak employment reports over the next two months, then QE3 is back on."
On whether there’s a risk of a double-dip recession:
"I think so, if liquidity disappears. That was the recessionary implications of 2008 and 2009. Investors fled to cash and it was up to the central banks to re-liquefy the markets and to lever the markets, which they have done. If you have problems in euro land where money basically flees to the center, to Germany, to banks, to cash, as opposed to outward, then euro land continues with their recessionary environment. Ultimately that effects the United States. We at PIMCO are not believers that the United States can simply go it alone on this 2-3% growth path without other countries and other continents participating at the same time."
On when inflation will hit:
"It has already started to hit. Let’s look at it this way. In a very slow-growth, in euro land, a very recessionary environment, we still have inflation at over 2%. It is really remarkable. The amount of easing we have seen over the past three years in terms of quantitative easing and extremely low policy rates everywhere has really been an inflationary thrust. I think even the Chairman would be willing to acknowledge that. None of them are willing to acknowledge that it will not come back down. They still think it will be 2% or lower. We suspect not. We suspect, like the Bank of England, Mervyn King always writes letters of apology, saying that the 3% inflation will really become 2%, all we have to do is wait. I think that will be the standard, you know, we will hear from the Chairman and other Fed officials that inevitable inflation will come back down to 2% or maybe lower, but I suspect it will not."
On whether a breakup of the euro zone will happen in the next several years:
"We certainly do not want that. A break up produces disastrous short-term consequences. I think markets know that and policymakers know that, too. Euro land is a dysfunctional family, more dysfunctional than Democrats and Republicans in Washington, DC. The Germans versus the Spanish and the Germans versus the Greeks in terms of ethics so to speak and fiscal discipline is quite a disparity. It’s really that requirement for Germany to begin to write checks not only through the ECB, but to basically subsidize through their own fiscal maneuverings, that produces the problems. The Germans, for a long time, have supported East Germany in terms of the amalgamation of the two countries. They are not quite willing to go that far in terms of the big family in euro land and so those are the problems we see on a day to day basis."
On the employment reports coming out:
"They are beginning to move lower, it appears. Ben Bernanke spoke to that and answered some questions in terms of seasonality. We may have seen some strong seasonality in terms of prior reports, not last month’s, but the two before that. We have seen initial claims on unemployment move up today. They have indicated for the past three weeks that we are really moving into a weaker employment framework, which would probably produce 150,000 jobs, but not the 200,000 that really got the market excited."
On where he sees the 10-year at the end of 2012:
"I see it around 2%. It is dependent on the Fed continuing to buy 10-year Treasuries. It will be interesting in June to see what happens if the Fed stops writing checks. Basically the Fed says that this is a stock type of argument. It is really like a wine cellar. They have taken half of the wine out of the seller and now they basically said that at the end of June, it will be up to the private market to restock the wine cellar because it is empty. I basically take the flow view that says, hey, at 1.95%, not much of a value there. So let’s see, if the Fed doesn’t buy them, let’s see who else will. It will be an interesting experiment at the end of June if the Fed does not do a quantitative easing, but for the moment, I think the 10-year stays at where it is."
On mortgage-backed securities:
"Mortgages benefit from inactivity and low volatility. A mortgage can prepay or a mortgage can not prepay. So that shifts the average life of a mortgage back and forth. For that negativity and for that optionality that that mortgage holders holds, you get a higher yield. If you expect yields to stay the same for the next one, two or three years, then the 100 or 150 basis points from a mortgage is much better than 2% from a 10-year Treasury."