Investors are getting a touch nervous about when the U.S. Federal Reserve will pare back its extraordinary monetary policy stimulus.
Not Bill Gross. The managing director of the fixed income investment firm Pacific Investment Management Co., or Pimco, believes that ultralow interest rates and aggressive bond-buying, championed by Fed chairman Ben Bernanke, are weighing on the U.S. economic recovery – and must go.
“It’s been five years, Mr. Chairman, and the real economy has not once over a 12-month period of time grown faster than 2.5 per cent,” Mr. Gross said in his latest investment strategy note. “Perhaps, in addition to a fiscally confused Washington, it’s your policies that may be now part of the problem rather than the solution.”
Under Mr. Bernanke’s leadership, the Fed slashed it key interest rate to zero per cent during the depths of the financial crisis and added another layer of stimulus by buying Treasury bonds and mortgage-backed securities, using a program known as quantitative easing or QE. Recently, the Fed has been buying bonds at a clip of $85-billion (U.S.) a month.
Many observers, including Mr. Gross, acknowledge that the extraordinary measures have helped rescue the economy from a deflationary spiral. In fact, the United States now looks like one of the few bright lights in the global economy, with rising employment, a recovering housing market and positive, albeit sluggish, economic growth. Compare that with Europe, which is mired in recession with double-digit unemployment.
Stimulus has also sent stock prices on a tear, with the S&P 500 up 140 per cent from its lows in 2009. Yields on bonds have been exceptionally low, despite recent increases.
But there’s the problem, according to Mr. Gross: Fed policies, along with those of other central banks, have encouraged investors to accept a meagre payback for the risks they are now taking.
“Central banks … seem to believe that higher and higher asset prices produced necessarily by more and more QE cheque writing will inevitably stimulate real economic growth via the spillover wealth effect into consumption and real investment,” he said. “That theory requires challenge if only because it doesn’t seem to be working very well.”
That is, economic growth rates haven’t returned to normal. For someone such as Mr. Bernanke, this subpar growth along with an unemployment rate of 7.5 per cent points to the need for continuing stimulus.
Mr. Gross, though, believes that low rates and stimulus must go. Savers can’t generate income, which limits consumption and growth. The financial industry is struggling with low net interest margins, which threatens employment at retail branches. And companies are resorting to financial engineering rather than far more productive research and development.
His remarks come as investors and some stock market strategists ponder the same thing, but from a different perspective: How will the economy and stock market perform without the Fed’s assistance?
“[Investors] fear that without the Fed’s propping of the bond market, interest rates will rise, leaving stocks vulnerable,” Jack Ablin, chief investment officer at BMO Harris Bank, said in a note.
Mr. Bernanke himself is well aware that withdrawing stimulus too soon could reverse the recent economic recovery, and Japan’s experience of suffering five recessions in 15 years bolsters his point.
Mr. Gross, who recently argued that the 30-year bull market in bonds is over and that investors should reduce risky assets, is betting that Mr. Bernanke will listen to his advice.
Let’s hope the Fed chairman takes a pass.