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Bill Gross: ‘Zombies’ Roam Economy Thanks to Low Interest Rates

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A day after the Federal Reserve decided once again not to raise interest rates, bond fund manager Bill Gross inveighed against the central bank’s near-zero interest rate policy, which has persisted for more than six years.

In his latest investment outlook for Janus Capital, where he’s the lead manager of the Janus Global Unconstrained Bond Fund (JUCTX), Gross writes that “low interest rates are not the cure – they are part of the problem.”

Despite near zero interest rates for almost 6-1/2 years, “corporate investment has been anemic,” writes  Gross. Quality companies are borrowing in huge quantities — $1.02 trillion in 2015 so far – because of low rates, but they’re using the money to buy back stock rather than to invest in growth, says Gross.

In addition, writes Gross, companies with extremely low credit ratings have been able to borrow at rates below 5%, creating “a host of zombie and future zombie corporations [who] now roam the real economy.”

It wasn’t supposed to be this way. “Historically the Fed and almost all other central banks have comfortably relied on a model which assumes that lower and lower yields will stimulate not only asset prices — but investment spending in the real economy … and a trickle-down effect leading to higher real wages.” But this “money for nothing policy” hasn’t worked as expected, writes Gross.

In addition, near zero rates also “sap banks’ interest margins … cause pervasive mispricing in financial markets and threaten the solvency of insurance companies and pension funds,” writes Gross, quoting from a Bank for International Settlements report.

On the flip side, near-zero rates have fed bull markets in stocks — in the U.S. and especially China — but maybe too much, raising “the patient’s temperature to threatening status,” writes Gross.  

Despite his scathing analysis of the Fed, Gross writes that the Fed and the Bank of England now are “wising up” to the dangers of low interest rates. Unless there’s a “global catastrophe,” he expects the Fed will raise rates at its next policymaking meeting in mid-September, as many economists and strategists do.

The Fed may have suggested as much in its latest policy statement released Wednesday, according to economists. More specifically, the Fed added the word ”some” to its boilerplate sentence of the job market:

“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” 

The change “suggests that officials only need to see a little more improvement” in the labor market before raising rates, write Jim O’Sullivan, chief U.S. economist at High Frequency Economics. And there will be two more jobs reports before then.

For his part, former Fed Chairman Ben Bernanke at this week’s LPL conference in Boston admitted that despite the Fed’s very easy monetary policy, business formation is not as strong as the Fed would like, and the bank’s policy of quantitative easing — buying back Treasuries and mortgage-backed securities to boost growth — has boosted stock prices, which may be exacerbating the growing income disparity in the country. But, Bernanke noted, quantitative easing has “helped to create 14 million jobs since the financial crisis.”

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