Gross and Hatzius: Jobs report below expectations, Fed will taper anyway
Both Bill Gross of PIMCO and Jan Hatzius of Goldman Sachs do not believe the weak jobs report will be enough to cause the Fed to call off its tapering of large scale asset purchases.
I agree here. And that is in large part because tapering is about rear-guarding the Fed’s reputation as the voices crying out about markets reaching for yield have grown. Tapering is not about the real economy. It is about asset markets. What might cause the Fed to stop tapering is a further big move up in mortgage rates. That’s my view.
Hatzius, for his part, feels that the economy is growing robustly enough that the Fed can safely taper:
Hatzius pointed out that although the jobs report disappointed, other recently released indicators, such as ISM and claims data, suggest positive trends for the market.
At the upcoming Federal Reserve meeting, Hatzius said that his expectation is that the central bank will begin a program of tapering its asset purchases, but “they will lean pretty hard on making it a dovish taper.”
He said the number could be “$20 billion or a little less” but said the dovish lean could include a reinforcement of forward guidance, a lowering of the unemployment threshold or introducing additional conditions that need to be met before hiking rates.
Those additional conditions could potentially include placing more weight on inflation targeting and employment-to-population ratios such as labor force participation.
PIMCO’s Bill Gross talked to Tom Keene on “Bloomberg Surveillance” right after the numbers were released and he agreed with Hatzius: “I think Bernanke and company are committed to a taper…It will be taper lite as opposed to a strong tapering.”
The Gross transcript is below. He agrees with me here that tapering is about froth in asset markets and the Fed is committed to this path for that reason.
Source: Bloomberg Surveillance
Gross on today’s jobs report being the new normal:
“Yes, it sure was. And I guess the revision of last month was the biggest shocker. And the fall, of course, as you mentioned in terms of the participation rate from 63.4 to 63.2. You know, the unemployment rate is down, for those that focus on the unemployment rate, it is 7.3 percent. They would simply suggest we are closer to tapering and closer to a fed funds increase at some point. But I would suggest otherwise, that it is really a weaker economy as evidenced by today’s report.”
On whether the Fed will taper September 18:
“Yes, perhaps. I think they will. You know, much like the red line in Syria, I think Bernanke and company are committed to a taper and the sooner the better. The taper is really a factor not necessarily of the growth or the strength of the economy, but the fact that at some point, three to six months ago, Governor Stein, for instance, wrote about the impact that tapering and QE is having on risk assets and the potential for a bubble. So I think the fed is really focused on de-bubbling risk markets in terms of a frenzied narrowness of spreads, or even a frenzied peak in terms of equity prices. And they will taper in September, but it will taper lite as opposed to a strong taper. And what does that mean? That means to us perhaps $10 billion. And mainly, by the way, on the treasury side as opposed to the mortgage side.”
On whether this is two Americas:
“I think so. It has been for a long, long time…And as the rich get richer, the middle class, as Obama is want to characterize the poor, basically stands still or even moves in reverse as their wages don’t keep up with inflation. So it is certainly two Americas. At this point, and for the past three to four years, the fed and the government has focused primarily on reinvigorating the financial markets, which are the bastion basically of the first America, the one percent or the five percent. But 95 percent are not participating and that ultimately affects economic growth no doubt.”
On whether nobody wants to work in America:
“Well, I think people want to work. We’ve seen they want to work, but they want to work for a decent wage and the wanting isn’t necessarily fulfilled by global forces and by structural forces such as technology and corporate downsizing to improve bottom line targeting. So wanting a job or not wanting a job, to my way of thinking, is not really the factor – the headwinds of globalization which sees China and others replace U.S. jobs with technology, which sees robots replace jobs, and corporations which basically want to improve their productivity by eliminating jobs.”
On whether he’s having fun right now:
“Well, to me fun is characterized by challenge and competition. And certainly this market is challenging money managers, certainly bond managers in ways that they have never been challenged before. So to the extent that you want to play in the Super Bowl and to the extent that you want to be in the big time with a big time challenge, this is the time to play and I’m excited to do it.”
On how he frames the ten year yield future:
“Well, our view is dominated not by QE and tapering, which influences the ten year yield, but by the front end and how long the fed stays there. To the extent that they stay there until 2015 or 2016, that acts as a magnate so to speak, as a force that keeps the ten year from increasing, if only because the three percent yield and the roll down associated with it produce returns of four percent to five percent – very attractive. So if the Fed stays where they are and this morning, for instance, Evans suggested that it might take six percent unemployment to produce a fed funds increase, then basically there is value in the bond market, value in the ten year to your question. There is more value, in our opinion, in the front end because, believe it or not, the forward – see it gets a little complicated here – but forward interest rates, the fed funds future so to speak, in 2008 are anticipating nearly a four percent fed funds rate and we are at 25 basis points. That becomes rather ludicrous in the face of this particular report and the expectation that the economy remains in a new normal, as opposed to an old normal type of world.”
On whether he would predict now or in the near future that there will be serious illiquidity as there are bond portfolio redemptions:
“Perhaps in the market per se, not with PIMCO. I mean the total return fund has ten percent cash. We’ve got $25 billion in cash. So liquidity problems? No. I think what we’ve seen in core bond funds industry wide is an outflow. Because PIMCO total return is the biggest and the best, by the way, we get focused on in terms of the headlines. But our friendly competitors, Vanguard and Double Line and so on, are all in the same boat. In PIMCO’s case, when money comes out of total return, that is basically a choice on the part of an investor to move to either a lower duration or a different asset class, such as unconstrained bond funds, which have a lower duration target. And so PIMCO loses a little bit of flow in terms of total return, but gains that flow back with unconstrained or with an alternative asset. So PIMCO is not suffering. The total return fund is losing some assets, but that is a choice on the part of the investment public and we are well prepared for it.”
On what PIMCO is pinning its forecasts on:
“Right, a wonderful question. You guys all ask wonderful questions. In this particular case, we have talked about the fundamentals for the past few minutes. The markets are being influenced by what we call technicals as well. And this doesn’t refer to a head and shoulders pattern or a shampoo, but it refers to technical flows that are coming, or outflows, to put it frankly, that are being instigated, yes, by the fed and potential tapering, but also by retail. We just talked about that and pulling money out of core bond funds. Banks are under pressure in terms of regulatory influences and cutting down and reducing their assets. And believe it or not, foreign central banks, in the attempt to support their own currency and financial markets, are selling treasuries. So it is not just a question of the unemployment rate or the jobs report. It’s a question of whether these technical structural influences stop at some point. And, for the moment, they are feeding on themselves.”
On whether Bernanke is working out of a textbook:
“We talked about yesterday in an investment committee. It was sort of a joke, but not so much of a joke actually. There is the London school and the Chicago school. And I suggested perhaps the Phoenix school of economics in terms of modeling will now dominate going forward. There are legitimate questions as to whether increasing interest rates will be a negative for economic growth as opposed to a positive. And there are legitimate questions – this is Bernanke’s model – that lowering interest rates and quantitative easing has produced stronger economic growth. Yet one could say, if you are in Phoenix I suppose, that the higher the interest rate and the higher the return on investment in real assets, that being plants and equipment, houses and so on, that the more opportunity and the higher willingness to invest. So, yes, London, Chicago, Keynes, neo-Keynes, perhaps we’re all in a world in which models are being readjusted as we speak.”
On where the economy is going:
“We still see a two percent U.S. economy. We think in the last month that the economy has been proceeding at 2.5 percent. And yes, as fiscal austerity becomes a little bit less as we move into 2014, perhaps you see stronger growth. And we’re seeing importantly euro land flattening out at least and the U.K. exhibiting two percent to three percent growth. So the world itself is doing better, aside from emerging. But the developed countries are doing better. So it’s a more decent forecast going forward. But the old three percent to four percent Minsky types of numbers, which can be produced by big government and what they call a big bank or a thing of the past if only because the labor force is only growing at 0.5 percent. And labor force growth at 0.5 percent, plus productivity at the high side – maybe two percent, only leads to 2.5 percent growth on a long term basis.”