Bill Gross called 10-year German bunds the “short of a lifetime” in a tweet on Tuesday.
He expanded on that comment in an interview with Bloomberg TV, suggesting investors wait another 12 to 18 months when quantitative easing ends in the eurozone before shorting the bund.
Gross, who manages the Janus Global Unconstrained Bond Fund for Janus Investments, blamed the bund’s overvaluation on quantitative easing, but also low growth in the eurozone and problems in Greece. “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 […] 30-year German bund at 50 basis points would probably move higher and the price would move lower.”
He acknowledged there is an event risk to shorting the bund, but said that Mario Draghi, president of the European Central Bank, had promised not to buy anything at a yield of less than minus 20 basis points. “If he’s good to his word then even in the case of Greece, a 10-year German bund at 10 basis points would have a limit in terms of a yield of minus 20 basis points, which would be a 30 basis point move.” Gross said such a move “in a nine duration world basically would imply, well, two to three points maximum downside risk.”
Based on assurances that the ECB’s quantitative easing policy will inject €60 billion each month into the economy until September 2016, Gross said that “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.”
Gross: German 10yr Bunds = The short of a lifetime. Better than the pound in 1993. Only question is Timing / ECB QE
— Janus Capital (@JanusCapital) April 21, 2015
Gross couldn’t say what the “ultimate trigger” for shorting the bund would be, but he noted that over the next five to 10 years, “it gets possible to evaluate a German bund and U.S. Treasury bond on an even basis.”
He said the expected inflation rate for the next five years will be around 1.9% in both Germany and the U.S., and the yield will be about 200 basis points lower in 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 […] 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,” he said.
To be clear, Gross said he doesn’t expect the 10-year bund to jump from 10 to 50 basis points in the next month, but “the key point is it doesn’t cost you anything.” Historically, he said, “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.”
The second part of Gross’ tweet recalled a move made by George Soros and Stanley Druckenmiller to short the British pound in the early ‘90s. However, Mark Gilbert, a columnist for Bloomberg, warned that widespread shorting of the bund could spell “financial Armageddon.” Soros and Druckenmiller made $1 billion on that bet, but Gilbert writes that when the U.K. stopped trying to prop up the pound to trade at around 2.95 deutsche marks, it fell 14%.
To replicate that performance, Gilbert said the bund price, which as of Wednesday morning was trading at 104 with a 0.09% yield, would have to fall over 89 points by May 13.
“At that price level, the yield would shoot up to almost 1.7%, causing a tsunami of repricing across trillions of dollars of government debt around the world,” Gilbert wrote.
He acknowledged that it’s “intuitively uncomfortable to be lending money to the German government for a decade in return for less than one-tenth of one percent,” so Gross may be right.
However, he wrote, if he is right, and the bund does follow the same trajectory as the pound, “investors will find themselves in the midst of a financial Armageddon that could make the Great Crash of 1929 look like a walk in the park.”
— Check out Bill Gross Blasts ‘Hostile’ Investing Climate, Says ‘New Neutral’ Rate Now Zero on ThinkAdvisor.