Did the Federal Reserve make the right call?
During a webcast from Janus, legendary bond fund manager Bill Gross commented on the Fed’s mid-March meeting where officials left interest rates unchanged and lowered its projected path for increases this year.
“Boy, it was a surprise I think to many of us,” Gross said. “A little more dovish than even the doves considered Yellen to be.”
In a statement at the conclusion of their two-day meeting last week, Federal Open Market Committee officials cited the potential impact of weaker global growth and financial market turmoil on the U.S. economy as reasons for not raising borrowing costs.
The Fed’s dovish statement should be encouraging for risk assets in the short term, according to Gross.
“Risk assets were encouraged by the ‘promise’ of liquidity going forward and the Fed suggesting that there’s not an interest rate hike in April and maybe not for the next several quarters,” Gross said. “I think, short term – and let me emphasize short term – that markets and especially risk assets are encouraged. I think on a longer term basis there are structural problems with what’s being done.”
While there are short-term benefits for risk assets, zero-bound or negative rates will affect savers’ ability to generate returns and threaten business models long term, Gross said.
“The closeness to the zero bound basically robs savers of their ability to earn money and threatens business models such as insurance companies and banks in terms of their margins and certainly pension funds in terms of their ability to earn money,” he said, adding, “The necessity to keep interest rates low in order to support markets has long-term consequences, and I’m not so sure the Fed appreciates that.”
While the Fed may not seem concerned, Gross said, investors should be concerned about being at zero-bound rates for a long period of time.
“There are negative consequences down the road, and I think we’ve seen that in Japan, because Japan’s been at these levels for a long, long time and failed to generate inflation or growth, and there are negative consequences in euro-land as well.”
Gross, who manages the Janus Global Unconstrained Bond Fund (JUCTX), discussed where he sees the best value in fixed income, following the Fed’s announcement.
“I think all developed market bonds are artificially priced,” he said. “We know that 40% of the developed market in the AA and AAA categories are at negative yield, so how could I say that there’s an attraction in the developed market even after [the March 16] rally in the treasury market? I think there’s risk in emerging market debt and countries such as Brazil and others that are, at the margin, extremely risky and extremely volatile.”
Janus’ unconstrained fund uses strategies that include “a number of equity arbitrage types of situations,” which according to Gross are non-volatile and can produce 4% to 5% returns. Gross also recommends closed-end funds.
“Closed-end bond funds in some cases sell at discounts of 10 to 15% to their asset value,” Gross said. “They’re mildly levered, therefore able to borrow at 50 basis points as opposed to invest in it, and produce yields of 7, 8, 9, 10%. Now many of those have high-yield bonds and you have to be careful.”
Gross, who admits he’s not a fan of the Fed, thinks central banks overall have “gone too far.”
A main problem with the Fed and central banks, according to Gross, is that they rely on old historical models such as the Taylor rule and the Phillips curve.
“I think the Fed and other central banks simply have to recognize we’re in a different world if only because of leverage and high levels of debt,” Gross said. “The Taylor model and the Phillips curve say nothing about leverage or high levels of debt, and we saw the consequences of that in 2007. Is there a high level of debt today? Not necessarily in the U.S. but certainly in global pockets such as China and other emerging market countries.”
According to Gross, central banks have yet to come to grips with leverage and the effect that leverage has on economic growth going forward.
—Related on ThinkAdvisor: