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Bill Gross - German 10-Year Bunds Short of a Life Time

Interest-Rates / Germany Apr 22, 2015 - 05:06 PM GMT

By: Bloomberg

Interest-Rates

Bill Gross of Janus Capital spoke with Bloomberg Television's Alix Steel about yields on the 10-year German bund, his bet against German debt and the European Central Bank's program of quantitative easing.

On shorting the bund, Gross said: "Most investors would probably want to wait for 12 to 18 months because that's when the Eurozone and the ECB's quantitative easing program ends. And one of the reasons for the overvaluation of bunds has to do with Mario Draghi and his program of EUR60 billion a month in terms of buying power. And so you don't want to fight the Fed or the ECB, I suppose, and then getting in early is doing that to a certain extent."


Gross noted: "Mario Draghi is good to his word, because he has told us he will provide liquidity for the next 12 to 18 months. He will be buying EUR60 billion, not just the German bunds, but easy country securities. And so the liquidity basically is a promise from Mario Draghi."

ALIX STEEL: Well joining me now with more on his call from Newport Beach, California, is Bill Gross. Bill, thank you for joining us today.

BILL GROSS: thank you, Alix, nice to be here.

STEEL: Always good to see you. Okay, so the question is timing. When is it? When would you put on this trade to short? 

GROSS: Well most investors, Alix, would probably want to wait for 12 to 18 months because that's when the Eurozone and the ECB's quantitative easing program ends. And one of the reasons for the overvaluation of bunds has to do with Mario Draghi and his program of EUR60 billion a month in terms of buying power. And so you don't want to fight the Fed or the ECB, I suppose, and then getting an early is doing that to a certain extent.

But I -- I would say that the overvaluation is due to a number of things. One, it's due to the low growth of the Eurozone; two, it's due to the quantitative easing program; and three, it's due to Greece. And if any of these should change direction, if the Eurozone should strengthen in terms of growth and the need for a quantitative easing program over the next 18 months, sort of diminish, or if Greece should be healed, so to speak, then the bid for a German bund, a 10-year German bund at 10 basis points, or let's go this way, 30-year German bund at 50 basis points would probably move higher, and the price would move lower.

STEEL: So, Bill I kind of hear from you that it's really the end of ECB QE that is going to be that short for you, but if the trigger for the end is kind of what's up for debate, what about the fact that Greece might not heal itself? We're seeing a yield there really sore, nearing 30 percent. The rhetoric is increasingly negative. Is there an event risk here to your trade?

GROSS: Well I think there is. To a certain extent it's alleviated by the fact that Draghi has promised us, and hopefully his promises are good on either side, but he has promised us he would not buy anything at a yield of anything less than minus 20 basis points. And so if that's true, if he's good to his word, then even in the case of Greece, then a 10-year German bund at 10 basis points would have a limit in terms of a yield of a minus 20 basis points, which would be a 30 basis point move, which in a nine duration world basically would imply, well, two to three points maximum downside risk. So I think Draghi has told us that he's going to buy some, but he's not going to get ridiculous.

STEEL: So you sort of laid out the how -- the if and when it might happen. What about the how? I mean what does it look like when your trade starts to unfold when the ECB comes out and says, okay, we're done with QE? 

GROSS: Well let me point out, Alix, that during the U.S. QE that actually nominal rates rose, even in the face of the Fed's buying, because inflation expectations were moving higher because of quantitative easing. What the ultimate trigger will be I'm not exactly sure, but I do know this in terms of valuation. And it gets pretty easy when -- when a bond yield is nothing. If you buy a 10-year bund, say it's zero percent you know you are getting nothing over the next 10 years.

What's at risk here is the next five and the next 10 years going forward, what will happen at that point in time. And it gets not easier, but it gets possible to evaluate a German bund and U.S. Treasury bond on an even basis because we know from inflation index to securities, from tips and inflation index securities in Germany that the expected inflation rate is about the same five years forward in both Germany and the U.S., about 1.9 percent, but the yield difference between those securities is about 200 basis points, 200 basis points lower for Germany.

So equal the quality, yes, but 200 basis points lower in Germany. What does that say? It either says U.S. Treasuries are a whale of a buy, or it says that U.S. -- German bunds are a whale of a short. I'm suggesting if you don't want to hedge that the best bet is to sell the bund as opposed to buy the treasury.

STEEL: I guess the reason why I was asking about how it unfolds is implying that this is the trade of a lifetime that means to me that you are going to make a lot of money off of the trade, which means we're going to see a lot of volatility and a lot of long sort of get trapped and have to liquidate fairly quickly. Is that the kind of liquidity exit that you are expecting in this scenario? 

GROSS: I -- I don't think so, as long as Mario is -- Mario Draghi is good to his word, because he has told us he will provide liquidity for the next 12 to 18 months. He will be buying EUR60 billion, not just the German bunds, but easy country securities. And so the liquidity basically is a promise from Mario Draghi. And to think that sellers would be rushing to the exit or shorters would be jumping in the pool, so to speak, I think is a little bit of a stretch. I don't expect that.

I don't expect the 10-year bund to go from 10 basis points to 50 basis points within the next month, but and here's the -- here's the key point. The key point is it doesn't cost you anything. Historically, over the past it cost an investor to short or to sell a security because that's a negative carry. There is no negative carry here. You can basically do a Rip Van Winkle, go to an island, come back in five years and know that the odds highly favor that you made a lot of money.

STEEL: Bill, good deal. Thanks for joining us. We really appreciate it, loved your tweet today. It was a lot of fun for us here in the newsroom, Bill Gross joining us from Janus Capital.


**CREDIT: BLOOMBERG TELEVISION**

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