Mon, 12 Sep 2011
Massive purchases of U.S. debt by the Fed and foreign governments has suppressed yields, pushing the risk/reward trade-off out of balance, says PIMCO's Bill Gross.
Jason Stipp: I'm Jason Stipp for Morningstar. Eric Jacobson, our director of fixed-income research, recently visited PIMCO and sat down with Bill Gross to get the noted bond fund manager's take on the macroeconomic picture, interest-rate risk, and his investment outlook today.
Eric Jacobson: Bill, thank you so much for joining us today. We appreciate it.
Bill Gross: You're welcome, Eric.
Jacobson: You've obviously have been writing and talking a lot in the last few months about your concerns with the macroeconomic picture in the United States, in particular, the budget issues and what have you. Give us a little more color, if you will, about the reasons of your underlying thinking there, and then I want to ask you some follow-up on how it affects portfolios.
Gross: Well, I think the macroeconomic view sort of gels nicely into the overpricing view in terms of Treasuries. Our view is that Treasuries are affected by the budget deficit and the potential to resolve it or to reduce it at least. But the moment $1.5 trillion deficit obviously is adding 10% of GDP supply to the Treasury debt on an annual basis, and that's significant.
On the other side, you have the Fed basically buying almost all of it, which to our way of thinking tends to suppress yield levels. It's hard to know exactly by how much. The Fed has done studies themselves that suggest anywhere between 50 and 100 basis points, which would mean that a 3.5% 10-year Treasury probably should be more like 4%-4.5% absent the quantitative-easing efforts and the issuance of Treasuries themselves.
In addition, there are significant foreign buyers, for example China and other central banks that aren't as picky, so to speak, in terms of the yields because they are trying to support labor growth in their own countries. And there's the fixing of the yuan to the dollar and the recirculation of funds back into Treasuries and it takes place at a relatively suppressed level too.
So our view is that because of the artificial buying in the marketplace, which might disappear at the end of June, in terms of the Fed, yields are vulnerable. We don't know by how much. But in any case, we have a sense that bond investors are not being rewarded relative to the risks that they are taking at the current moment.