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Catching a Falling Financial Knife

Lower Bond Yields Enticing PIMCO to Sell European Debt

Interest-Rates / Eurozone Debt Crisis May 03, 2013 - 04:59 PM GMT

By: Bloomberg

Interest-Rates

PIMCO's Bill Gross told Tom Keene and Michael McKee on "Bloomberg Surveillance" today that "lower yields and the higher prices are enticing us to gradually reduce our position" in European debt.

Gross also said that the new normal of subpar economic growth in the U.S. is intact even after employment increased more than forecast in April. Gross said, "We don't see higher real growth than 2 percent going forward...We've seen basically 3.5 percent nominal GDP growth even in the midst of an accelerating housing sector."


Audio Link courtesy of Bloomberg Surveillance:

http://media.bloomberg.com/bb/avfile/News/Surveillance/vY33M4TrXXWc.mp3
Gross on whether tepid GDP and disinflation is what we can expect from the U.S. economy over the next five years:

"Well, we continue to expect that. We have a secular economics forum that Mohamed [El-Erian] will be chairing next week. We'll give you some more answers I guess in the next few weeks. But nonetheless, what we have seen, Tom, over the past few months and over the past few years, since Mohamed came up with the term 'new normal' has been a 3.5 percent nominal GDP growth, which has reflected about two percent real growth and about 1.5 percent inflation. And do we expect that going forward? Yes, we do because there haven't been structural changes made to the economy."

On whether output gap is narrowing and GDP potential rising:

"Well, the output gap is narrowing, as we saw with the unemployment rate coming down. That suggests perhaps a little bit higher inflation from the standpoint of labor. And let's hope they get some of that. In terms of productivity and growth in the job force, no, we don't see much change there. We see global influences. We see potential negatives as far as the eye can see in euro land,. We see a hazy cloud of growth in China. And you put the package together and its influence on the United States is not necessarily significant, but it is important. And so we don't see higher real growth and two percent going forward, no."

On whether futures improving is a surprise:

"I think so. You know, we had been looking at strong jobless claims, but the gloom in terms of the manufacturing numbers and investment percentages and the growth rates there, it is a little bit of a surprise, the revisions as well. You mentioned March revisions; February revisions. We saw an increase in hourly earnings this time around, where it was flat last time. We did see the decline in the work week, a small decline, which was a minor negative. But it shouldn't diminish the positive nature of this particular report."

On his essay "There Will Be Haircuts" and whether the U.S. will have to write down debt at some point:

"We do. Typically what governments want us to do is to write it down gradually so that we don't know we're in the barber shop and certainly we don't know we're in front of Sweeney-Todd. The writing down of debt suggests, in some cases, like in Greece, and other areas, that the head will be dismembered.

But the haircutting that policymakers are doing come more surreptitiously in the form of negative real interest rates, higher inflation, currency devaluation, which is what we are seeing in Japan, capital controls, which is what we see in various countries like Brazil and China with their currency peg, and ultimately, as you mentioned, default, which is the ultimate resolution to a debt crisis."

On what return we should expect per year from bonds five and ten years out:

"It is like the oil filter man says, pay me now, pay me later. We are being paid now with some capital gains as interest rates come down. Not this morning, but typically the aggregate, the Barclays aggregate index, which includes investment grade mortgages and treasuries yields about 1.7 percent. And so you should expect 1.7 percent absent that brilliant alpha generation from PIMCO. But typically a bond investor is in a two percent to three percent world."

On where Europe's markets are headed:

"A cut on the policy rate that occurred yesterday, but importantly, as you mentioned, a hint that the deposit rate, the rate at which reserves earn interest when left at the central bank, that they might not only be zero, which they are now, but they might go negative, which is a stretch of the imagination or was up until yesterday. In other words, the banks - central bank might charge them money for safekeeping. And I happen to think that that reality is really far away. That that suggestion yesterday by Mario Draghi was really a form of moral suasion trying to entice the private sector further into the markets by buying bonds instead of the ECB buying bonds. But we'll have to see."

On whether he's enticed:

"No. If anything the lower yields and the higher prices are enticing us to gradually reduce our position."

On the possibility that Europe is going to ramp up securitization of ABS and whether that would work:

"I think they might be required. We have seen that in the U.K. as well in terms of a central bank becoming more directly involved in private market lending. It is an advanced debt, it is something that the fed did three years ago and has gradually exited. It is something that the Bank of Japan is doing. All central banks are basically merging fiscal and monetary policy and is that a good thing? To us, it is not a good thing. Is it a necessary thing? Perhaps, but it does produce consequences going forward and haircuts for investors going forward as well."

On whether dividend growth can be a constructive alternative to bonds priced to perfection:

"Well, certainly. And I think, to be fair to us, over the last year or two we have favored stocks versus bonds. What we have said, Tom, is that both asset categories - I mentioned bonds and their two percent to three percent return category. The stock story we think are in the four percent to five percent category. Does that mean that that is a great return? Certainly not relative to historical parameters. And can they increase dividends going forward? Of course they can. You know, dividends can increase. But let's be fair, too, that top line revenue growth, Tom, of the S&P 500 is basically flatlining here. And any dividend growth basically comes out of, yes, existing profits, and, yes, out of the -

On whether dividend growth and buybacks a la Apple is taking away from an investment that can create jobs:

"Most certainly, yes. And not to criticize Apple because they are a good client and they do what they have to do and perhaps there is not an investment out there that would absorb $100 billion to $200 billion worth of cash, and so there is a little bit of financial engineering there. But let's face it, what Apple has done has been done basically by the United States over the past several years. They have bought back our bonds, so to speak, and they have stimulated fiscally. But there has not been any real, direct investment to produce future growth. And so Apple is indicative I think not only of the technology sector, but of the United States as a whole that is lacking in investment and is lacking in productivity going forward."

On who should take over as chairman of the Federal Reserve:

"Oh, we don't want to nominate any particular one. I think PIMCO would want to see a chairman with a common sensical attitude towards the policy rate that includes savers as well as investors in stocks."

On whether it should be El-Erian:

"Oh, Mohamed is not going to Washington. His wife would never let him."

bloomberg.com

Copyright © 2013 Bloomberg - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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Catching a Falling Financial Knife