Following up on his May investment outlook, in which he argued that “If the neutral policy rate was 2% instead of 4% then bonds, instead of being artificially priced, would be attractively priced,” in his June commentary, PIMCO’s Bill Gross goes deeper into the neutral policy rate debate, arguing that the real neutral rate should be at zero or close to it. He also conveniently provides a shortened takeaway of his latest thoughts:
1) PIMCO’s New Normal evolves into “The New Neutral.”
2) “The New Neutral” is a central bank’s policy rate that is just right. Not too restrictive, not too stimulative.
3) PIMCO believes that “The New Neutral” real policy rate will be close to 0 as opposed to 2%–3% in prior decades.
4) If “The New Neutral” rates stay low, it supports current prices of financial assets. They would appear to be less bubbly
That’s helpful, but the popular takeaway from his latest monthly commentary will probably be (if social media is any guide): Bill Gross doesn’t own a cellphone.
Gross begins his June investment outlook by lamenting that the younger generation is trying to freeze time, using handheld devices like, umm, a cell phone to “record and memorialize” events for other’s viewing pleasure or for future consumption. “My view is that there is time stored in that cellphone, but its vintage may be somewhat sour, as compared to the sweetness of the here and now,” he writes. He then cites a Pew study on the heavy use of texting by American teenagers who “may get so caught up in their frantic ‘busyness’ that they fail to capture their present.”
So he pleads instead for “living in the moment.” As for cellphones, “They may be virtual, but they’re not reality.”
Then he gets into the meat of his commentary, saying “PIMCO’s reality in recent months has been captured by the phrase “The New Neutral,” defined as a real Federal Reserve Fed Funds rate of 0%, or perhaps even a little below 0%. Moreover, that zero rate, citing work done by Thomas Laubach and John Williams of the Fed, has declined “from over 4% in early 1970 to below 2% (and heading lower) today. Their most recent calculation of the current ‘cyclical’ rate is actually -0.25%.” Gross argues that when it comes to this New Neutral rate, “things are just gonna be this way for at least the next 3–5 years, and likely much more.”
So what does a “neutral” rate mean? Gross says Janet Yellen’s Federal Reserve answers it as “the rate consistent with full employment trend growth and stable prices.” He then quotes Yellen when she was San Francisco Fed President in 2005: “Research suggests that the neutral real rate depends on a variety of factors – the stance of fiscal policy, the trend of the global economy … the level of housing prices, the equity markets, the slope of the yield curve … and it changes over time.”
Gross says PIMCO “cannot quarrel with such logic” before suggesting that the New Neutral real rate is also determined by two other factors: slower labor force growth and productivity and financial system leverage. He then cites Paul McCulley’s past research on “The New Neutral” (McCulley just rejoined PIMCO as chief economist, reporting to Gross) in which he argued, said Gross, that “the price of ‘real’ short-term credit” should be “close to 0% real because there was so much of it that was finance as opposed to real economy related.”