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Bill Gross: Fed Rate Hike Will Be ‘Too Little, Too Late’ to Restore ‘Old Normal’ Prosperity

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If you can skim through the beginnng of Bill Gross’ latest investor outlook, “Sizing Up the Global Economy,” you’ll get to the heart of what is on his mind these days: Fed tightening.

Gross, portfolio manager of the Janus Global Unconstrained Bond Fund, sees the Fed’s tightening cycle as “too little, too late.”

The Federal Reserve may have missed its “window of opportunity” in early 2015, he says. Plus, the bond big wants “a new neutral policy rate which should be closer to 2% nominal, but now cannot be approached without spooking markets further and creating self-inflicted ‘financial instability.’ ”

While the Fed seems focused on raising the Fed funds rate “if only to prove that they can begin the journey to ‘normalization,’ ” the group must careful, he adds: This is because “ ‘one and done’ represents an increasing possibility – at least for the next six months.”

The problems with the Fed’s six-year period of zero-bound interest rates are numerous, according to Gross. First, it means the destruction of “historical business models essential to capitalism such as pension funds, insurance companies, and the willingness to save money itself,” he explains.

Without savings, there’s little investment and weak long-term productivity – “the decline of which we have seen not just in the U.S. but worldwide,” Gross states.

And there’s more. The imbalance between savings/investment and consumption, Gross explains, “is not the only Frankenstein creation” of zero percent yields.

Artificially low yields “have propelled financial markets and have impacted the real economy in numerous ways,” which he lists as follows:

  1. Global growth – commodity-based versus non-commodity based countries
  2. Currencies
  3. Policy rates and forward yield curves
  4. Monetary and fiscal policies
  5. Balance of payments/trade balances
  6. Debt levels
  7. Demographics in individual countries
  8. Equity and debt risk spreads – financial bubbles

Call the Doctor?

“The global economy’s finance-based spine is so out of whack that it is in need of a major readjustment,” said Gross. However, even the best chiropractor “could not even attempt it.”

In addition, a “one-off” Fed fund increase is not going to straighten it out, he adds.

“Major global policy shifts – all in the same direction – are required that emphasize government spending as opposed to austerity and that recognize that competitive devaluations do nothing but allow temporary respite from the overreaching global problem of  ‘too little aggregate demand’ vs. ‘too much aggregate supply,’ ” he explained.

Just as there have been calls over the past few decades for Japan to embrace consumerism, it’s now China’s turn. “China must move more quickly to a consumer-based economy,” Gross stated.

The developed world has to support such a shift be de-emphasizing fiscal austerity, he says, spending money on repairs and replacements of its decaying infrastructure.

Investor Outlook

The above recommendations, Gross admits, are politically “Pollyannaish.”

The portfolio manager doesn’t see the Merkel-dominated EU changing its tack any time soon, nor does he expect Bernie Sanders to be elected president in the U.S.

Without growth-enhancing policies, capital gains and future returns from the world’s equity markets should “be limited if not downward sloping,” Gross says.

As for high-quality global bond markets, investors should expect to find “little reward relative to durational risk.” And private equities and hedge funds can’t really prosper “if global growth remains anemic.”

Yes, that leaves … cash “or better yet ‘near cash’ such as 1-2 year corporate bonds are my best idea of appropriate risks/reward investments,” Gross argues. “The reward is not much, but as Will Rogers once said during the Great Depression – ‘I’m not so much concerned about the return on my money as the return of my money.’ ”

And he gets even more pessimistic. The return of your money “will likely not pay for college, health care or retirement liabilities. That is the near global conundrum we are faced with as near-zero-percent interest rates limit capital gains in the future, and if raised too high, will lead to red-zone losses,” he explained. “Not much else to say here.”

Thanks to a world with zero-bound interest rates, we face global imbalances that restrict productive growth and limit the chances for “old normal” prosperity, Gross concludes.

(For his thoughts on everything from pets to singer-songwriter Randy Newman, read the full outlook piece here.)

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