Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
PIMCO's Bill Gross joined Dan Gross on Yahoo Tech Ticker to discuss a host of bond related and economic views. Much like myself, he sees another round of QE (sterlized or otherwise) – in fact he takes it another step further and says there is a good chance of QE4 as well. 
Another round (or two) of quantitative easing from the Federal Reserve, muted growth and an end to the 30-year bull run in government bonds. That's what Bill Gross, one of the largest bond investors in the world, sees for the U.S. economy in the coming year.
Gross says long-term interest rates have been rising in recent weeks for two principal reasons. "Yes, inflation is rearing its head. We're seeing that in oil prices and other commodities, and we're seeing it in the numbers," he said. The consumer price index has risen 2.9% in the past 12 months. In addition, Gross says, the Federal Reserve's "Operation Twist" is scheduled to end in a few months. Under this plan, the Fed sold short-term debt and purchased long-term bonds in an effort to keep longer-term interest rates lower. At its meeting earlier this week, the Fed indicated that it didn't plan to extend the operation. "Yields have risen based upon the possibility that the Fed simply stops buying long-term bonds," he said. "If they do that, the question becomes, who is left?"
Despite the Fed's communiqué earlier this week, Gross doesn't believe the central bank's interventions in the bond markets are over. In two rounds of quantitative easing (QE), the Federal Reserve printed money to buy hundreds of billions of dollars of Treasury bonds and mortgage-backed securities. "I believe there will be a QE3, and perhaps a QE4," he said. Why? In the past few years, whenever central banks have stopped or paused their quantitative easing efforts, "stock prices have fallen and economies have slowed." The globe's private economies simply aren't sufficiently strong enough to support robust growth, and the world's central banks aren't willing to stand by and watch. "That's not a policy recommendation, it's simply a realization that the substitution of central bank monetary purchases will continue for a long time, as long as they [central banks] try to support private economies on a global basis," Gross said.
Still, Gross believes the 30-year long bull run for bonds may be coming to an end. "We're certainly close and have been close for a number of months," he said. It's very difficult to imagine interest rates going lower. "The bond market, whether it's Treasuries, mortgages, or investment-grade bonds in combination, basically yield a little higher than 2%," Gross said. "And unless the U.S. economy replicates Japan, where yields are down to 1% on average, then you'd have to say that we're close to the bottom in terms of yield." He adds: "It doesn't mean the beginning of a bear market, but it does suggest at least that the great bond bull market since 1981 is probably over."
Recent market activity in some bonds certainly ratifies that view. In recent weeks, the yield on the 10-year Treasury has risen from about 1.8% in late January to about 2.28% on Thursday. But "those yields aren't attractive," Gross says. Gross recommends that investors avoid longer-term bonds — i.e. 10-year and 30-year bonds — whose prices may fall if long-term growth and inflation expectations rise. However, they should also avoid short-term bonds. "The Fed has conditionally guaranteed that they won't be raising interest rates until late 2014, and that's almost three years from now." Gross believes that bonds that mature in five, six, or seven years occupy the sweet spot in today's market.
Bond holders tend to fear strong growth because it has the potential to ignite inflation and boost interest rates, thus reducing their returns. Gross says that while the economy has improved, it shows no signs of overheating. He believes the U.S. economy is growing at about a 2% annual rate in the first quarter "and probably beyond." That's about as good as can be hoped for. While the Federal Reserve has injected close to $1 trillion into the U.S. economy in the past year, growth is in large measure tied to what happens in the global economy. And the omens from abroad aren't particularly good. "China is slowing and the euro land is in recession," Gross said. The U.S. is growing at a decent clip, "what we call a new normal, but it probably won't get back to the 3 or 4% real growth numbers that we witnessed over the past decades."
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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
