Bill Gross is not happy with the decision by the Federal Reserve’s FOMC members “to hold off on their goal of normalizing interest rates” while the European Central Bank threatens to extend its quantitative easing policy with “more checks and more negative interest rates.”
Raising rates as Federal Reserve Board Chairman Paul Volcker did in the 1970s, he contends, led the financial markets to enjoy “positive real yields and a kick in the pants boost to other asset prices.” However, when “model-driven” central banks focus on employment numbers and “their ultimate impact on inflation,” their zero or 0.25% “financially suppressed yields” act as an “economic ‘sinker’ that ultimately lowers economic growth as well.”
“Zero bound interest rates destroy the savings function of capitalism, which is a necessary and in fact synchronous component of investment,” Gross writes in his early release October Investment Outlook for Janus Capital. He admits that while corporations have benefited by borrowing at the prevailing low rates and could have invested the proceeds “in the real economy,” they haven’t done so. Instead, those corporations have “plowed trillions into the financial economy as they buy back their own stock with a seemingly safe tax advantaged arbitrage.”
Gross, who almost exactly a year ago left PIMCO to become manager of the Janus Global Unconstrained Bond Fund, thus echoed the frustration felt by many economists and market watchers, such as Jeremy Grantham. In a June speech at the Morningstar Investment Conference, Grantham railed against the current corporate culture in which low interest rates have made it “desperately appealing” for corporate managers to borrow funds and buy back stock “at an annualized rate of $600 billion.” Buoying corporate profits through buybacks rather than capital expenditures and other business-building steps, like adding employees, is particularly appealing to managers since their compensation comes increasingly from bonuses and stock options, Grantham argued.
In his September Investment Outlook, Gross directed similar ire at the Fed, writing that the imbalance between savings/investment and consumption, “is not the only Frankenstein creation” of zero percent yields.
In his latest commentary, Gross extends the deleterious effects of zero interest rates, which he says destroy “existing business models such as life insurance company balance sheets and pension funds.” Those entities have assumed they could pay for their liabilities — “benefits for an aging boomer society” — with long-term 7% to 8% returns from a balanced portfolio of stocks and bonds. But with corporate bonds yielding only 2% to 3%, it’s become “obvious” to insurers and pension funds that “to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10% a year to meet the targeted assumption,” Gross writes. “That, of course, is a stretch of some accountant’s or actuary’s imagination,” he says wryly.