For most of 2015, famed bond investor Bill Gross has been railing against the Federal Reserve’s zero interest rate policy, urging the Fed to raise short-term interest rates because current low rates are stalling economic growth and short-changing savers.
But today, Gross proposed a new tack for the central bank: raise its inflation target, now at 2%, and sell long-term Treasuries and mortgage-backed debt from its trove of more than $2 trillion and use the proceeds to buy two- to five-year debt.
This latter strategy, which Gross calls “Operation Switch” – the reverse of the Fed’s former “Operation Twist” strategy — plus a higher inflation target would steepen the yield curve, undoing the flattening curve that has been depressing growth, writes Gross in his latest investment outlook from Janus Capital.
“Capitalism does not function well, and profit growth is stunted, if short-term and long-term yields near the zero bound are low and the yield curve inappropriately flat,” writes Gross, who manages the Janus Global Unconstrained Bond Fund.
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Gross explains that a flattening yield curve, with rates near zero, and the expectation of continued low rates reduce bank profit margin, corporate profits and any incentive to invest long term.
“It would seem that lower borrowing costs in historical logic should cause companies and households to borrow and spend more,” writes Gross. “The post-Lehman experience, as well as the lost decades of Japan, however, show that they may not, if these longer term yields are close to the zero bound.”