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Bill Gross, the founder of the world's largest bond fund manager Pimco, thinks thinks the six month rally in risk assets has reached its pinnacle and that the US Fed must keep interest rates low for up to 18 months.
In his latest colouful investment commentary published on the Pimco homepage, Gross discusses why in the 'new normal' following the financial crisis almost all assets appear to be overvalued on a long term basis, and that as a result policy makers must maintain artificially low interest rates and supportive easing measures to keep economies on track.
He thinks it could be up to 18 months until the Fed raises rates. 'My sense is that nominal GDP must show realistic signs of stabilizing near 4% before the Fed would be willing to risk raising rates,' Gross says. 'The current embedded cost of US debt markets is close to 6% and nominal GDP must grow within reach of that level if policymakers are to avoid continuing debt deflation in corporate and household balance sheets. While the U.S. economy will likely approach 4% nominal growth in 2009’s second half, the ability to sustain those levels once inventory rebalancing and fiscal pump-priming effects wear off is debatable. The Fed will likely require 12–18 months of 4%+ nominal growth before abandoning the 0% benchmark.'
Gross, whose firm runs $840 billion in assets, says that treasury bills at 0.15%, two year notes at less than 1% and ten year maturities at a 'paltry' 3.4% 'is all a treasury investor can expect,' without a period of deflationary momentum. Investors expecting the rally in risk assets to continue may be sorely disappointed, he thinks.
'What you see in the bond market is often what you get,' he says. 'Broadening the concept to the US bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point.
'Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates.
‘Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.'