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Talk of US Rate Hikes is Comical Says Pimco Chief Bill Gross

Interest-Rates / US Interest Rates Aug 05, 2008 - 07:51 PM GMT

By: Mike_Shedlock

Interest-Rates Yahoo!Finance is reporting Fed Can't Raise Rates .
The Federal Reserve's decision to hold the line on interest rates was the only move the central bank could make considering the state of the US economy, PIMCO chief Bill Gross said on CNBC.


Reacting to the Fed's move to hold its key interest rate at 2 percent, Gross called talk of rate hikes "comical."

"We're in a recession. When has the Fed ever raised rates in a recession?" he said. "Unemployment is headed toward 6 percent, mortgage rates on home buyers are at 7 percent, and these guys want to raise rates?"

My Comment: I often disagree with Gross, but this is extremely easy to follow logic that I am 100% in agreement with. The Fed is not hiking.

Gross said the central bank has a responsibility now to provide liquidity.

"We're in an asset deflation of near-historic proportions. That calls for the use of the government's balance sheet and not for the Federal Reserve to raise interest rates," he said. "To the extent that the central banks now must prevent that deflation, interest rates don't go up, they go down."

My Comment: In the US, the only asset deflation of historic proportion we are seeing is in housing. However, commercial real estate is coming, as is equity deflation.

In parts of the world (China and India for example) an equity crash of historic proportions is indeed underway. And to top it off credit risk is soaring in spite of the Fed's historic efforts to increase liquidity.

With this backdrop, screams of inflation are ridiculous.

"In the US, 2 percent is pretty much the floor. I think the Fed made that clear," he said. "They're going to provide liquidity in different forms and fashions."

As for investments at this point in the market, Gross advised against junk bonds and toward government-backed securities.

My Comment: It remains to be seen if 2% is the floor or not. I doubt it. Restraints on the Fed will also be lifted depending on what the dollar and commodities do. Actions of foreign central; bankers also come into play. Finally, things also depend on whether or not the Fed gets authority to pay interest on reserves.

The statement about providing liquidity in other fashions is certainly true as witnessed by an alphabet soup of lending facilities (TAF, PDCF, TSLF)which have now been extended.

Gross's advice against junk bond is rock solid. Junk will get hammered as default risk rises.

"We want to stay under the umbrella to the extent that we have an umbrella that shelters large banks and to the extent that we have an umbrella that shelters the agencies, Fannie (FNM) and Freddie (FRE), that's where you want to be," he said. "Why mess with junk bonds? Let's stick to high quality and stay under that umbrella. Let's stay dry."

My Comment: Gross made his bet, and that bet was that Fannie and Freddie would be bailed out at taxpayer expense. That bailout has been estimated at $25 billion. $250 billion might be closer. One does not have to like it (I sure don't) but it is what it is.

Point by point I agree with Gross. What I frequently disagree with Gross about are his proposed solutions, such as but not limited to, bailing out Fannie Mae.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2008 Mike Shedlock, All Rights Reserved

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