The age of easy money is beginning to unwind. In the U.S., barring any catastrophic black swan event, the Federal Reserve is expected to raise rates for the first time in more than nine years when policymakers meet in mid-December. Europe is still cutting rates, and the European Central Bank, along with the Bank of Japan, continue to purchase assets under their respective quantitative easing policies, similar to what the U.S. did for years after the financial crisis.
But this week when the ECB failed to announce an expansion of its QE program and cut its deposit rate less than expected, global financial markets swooned. The Dow fell 252 points, or 1.4%, while the Stoxx Europe 600 lost 3.1%, its biggest daily drop since Aug. 24, the day of the last flash crash, and German bund yields rose.
“The market … had a sense that since the amount wasn’t increased that perhaps the ECB is the last bastion of quantitative easing and monetary easing policy basically is at its limits,” Bill Gross told Bloomberg TV Friday morning.
In his latest investment outlook for Janus Capital, Gross writes that “central banks are casinos,” printing money as if they’re manufacturing gambling chips that never have to be redeemed and doubling down on their bets, until their respective economies improve.
He likens the central banks’ strategy to the Martingale in gambling, where a player doubles his bets every time he loses one in order to eventually win back all that was lost. “Given an endless pool of ‘chips’ the theory is nearly mathematically certain to succeed, and in today’s global monetary system, central banks are doing just that,” writes Gross.
Indeed on Friday, a day after the ECB disappointed financial markets, ECB President Mario Draghi said, “There is no doubt that if we had to intensify the use of our instruments to ensure that we achieve our price stability mandate, we would.”
Gross argues that these very easy monetary policies can’t go on indefinitely because eventually investors will lose faith. Then the currency under that central bank’s leadership will crater and inflation will rise, bringing down the value of that country’s – or region’s – financial markets.
In the meantime, wrote Gross, QE and artificially low interest rates will “keep alive” unproductive “zombie corporations” and destroy the business models of insurance companies and pension funds “because yields are too low to pay promised benefits,” turning “savers into financial eunuchs.”
He continued: “One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down.”
Gross recommends that investors “gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money.”
In the meantime Gross, like many money managers, expects the Fed will raise rates at its mid-December Federal Open Market Committee meeting given Friday’s strong jobs report. November payrolls rose 211,000, wages gained 0.2% and the unemployment rate was unchanged at 5%. By early afternoon, the Dow was up 341 points, nearly 2%, at 17,818.
The Fed is “certainly set to go,” Gross told Bloomberg TV on Friday. “It’s going to be an interesting experiment over the next three months or so.”
A day earlier Fed Chair Janet Yellen, speaking to the Joint Economic Committee of Congress, indicated that Fed is ready to begin raising rates but the increases will be gradual.
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