Greenspan Should Raise Rates, Bill Gross Says: Rates of Return
By Al Yoon
New York, Feb. 7 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund, said Federal Reserve Chairman Alan Greenspan has failed to bring down long-term borrowing costs with 11 reductions in the overnight lending rate between banks. The only way he can succeed now is if he raises interest rates, says Gross.
``Am I daring Greenspan to raise interest rates?'' said Gross, whose firm manages $240 billion. ``Sure, if only to bring down interest rates at the long-end of the curve and to give the economy a chance to recover over the long-term,'' he said.
Thirteen months after Greenspan began to lower the federal funds rate by a total of 4.75 percentage points, the yield on ten- year Treasuries, which set borrowing costs for companies and mortgages, has declined about a quarter-point to 4.9 percent.
Boosting short-term rates would be a ``masterstroke'' that would cut demand for two- to five-year government notes and increase purchases of 10- to 30-year debt, said Gross, who manages the $48 billion Pimco Total Return Fund at Pacific Investment Management Co.
Gross said the Fed, which only directly controls its target for overnight bank loans, needs to find a way to bring down home mortgage and corporate borrowing costs to ensure an economic recovery. The recession, which started in March 2001, has prompted companies to slow investments, cut costs and lay off an average of 152,000 workers a month, the most since in a decade.
``Corporate investment isn't going to benefit and the mortgage refinancing influence on the economy is going to die'' unless long-term rates come down, Gross said. ``The health of the economy ultimately depends on more investment.''
Aggressive Cuts
The Fed's most aggressive series of rate cuts in Greenspan's tenure were ineffective in bringing down 10- and 30-year Treasury yields. That created an incentive for investors to buy securities with maturities between six months and five years, not longer-term securities, Gross said.
Treasury bills, which mature in one-, three-, and six-months and two-year Treasury notes are the most sensitive to changes in the Fed's target rate, called the federal funds rate. As investors expect the central bank to cut rates, they push yields on those securities lower. Ten-year notes and 30-year bonds are traded more on expectations for inflation.
As investors bought Treasuries maturing in five years or less they profited as yields fell. An investor who bought and held a five-year note since the end of 2000 has earned a return of more than 9.5 percent, including reinvested interest. By contrast, investors who did the same with 10-year Treasuries earned less than 8 percent.
Investors may do the opposite if the Fed threatens to increase its target rate, Gross said. A rate increase would ``eliminate the excessive financial leverage hedge funds and government-sponsored enterprises have exercised'' as they bought short-term securities and sold Treasuries maturing between 10 and 30 years, he said.
Paul Chellgren, Chief Executive Officer and Chairman of Ashland Inc., the maker of Valvoline motor oil, agreed with Gross that the Fed needs to focus on bringing down 10-year note yields to bolster the economy. ``Some of the benefits of the extraordinary loosening of monetary policy haven't flowed through to the consumer,'' he said.
Lower Rates
Some investors said the relationship between the Fed's target and long-term rates isn't as simple as Gross suggests. In 1994, when the central bank lifted the fed funds rate by 2.5 percentage points, 10-year note yields rose 1.91 percentage points and two- year note yields increased at a faster pace to 7.7 percent from 4.3 percent.
In 1994, when the economy was recovering, many traders ``didn't make money'' because their bets on a narrowing gap between two- and 10-year Treasury yields were too early, said Michael Cheah, who invests $1.5 billion of fixed-income assets for SunAmerica Asset Management.
Paul Kasriel, chief economist at Northern Trust Securities in Chicago, said raising fed funds may reduce long-term rates with side effects that may be worse. It could also discourage banks from making loans, which would be a drag on growth, he said, ``If Greenspan's goal is to bring long rates down, a Fed funds rate increase would do it -- but that's kind of a Pyrrhic victory,'' he said.
Gross said long-term rates should also decline as investors become convinced that inflation isn't a threat. He expects the increase in consumer prices to slow to 1 percent to 1.5 percent this year. Inflation erodes the value of the future payments investors receive from fixed-income investments.
Gross doubts Greenspan will follow his advice. ``It's sort of a contrarian view,'' he said. |
