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Bill Gross, Mohamed El-Erian Warn Against Counting the Fed Out

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Three of the world’s most influential bond investors say the Federal Reserve is still on course to raise interest rates this year, a view the head of the New York Fed signaled could happen twice — even after April’s smaller-than-predicted gain in jobs.

Bill Gross, former manager of the biggest bond fund, said policy makers may act at their next meeting in June. Mohamed El-Erian, chief economic adviser at Allianz SE and a Bloomberg View columnist, said the Fed may move twice this year. Mark Kiesel at Pacific Investment Management Co. and New York Fed President William Dudley echoed the comments.

Gross and his peers are warning investors not to count out the Fed after the Labor Department reported U.S. employers added 160,000 workers last month, short of the 200,000 positions projected in a Bloomberg survey of economists. Fed Chair Janet Yellen is also examining earnings, which rose 2.5 percent from a year earlier, more than forecast. Two-year note yields, according to Gross, are too low.

“I’m not so sure that June is out,” said Gross, formerly of Pimco and who now runs the Janus Global Unconstrained Bond Fund,  speaking on Bloomberg Television May 6. “Yellen, more than jobs, is focused on wages. At 2.5 percent, they’re moving up.”

Price Isn’t Right

The yield on the benchmark 10-year note fell two basis points, or 0.02 percentage point, to 1.76 percent as of 9:17 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 1.625 percent security due in February 2026 rose 1/8, or $1.25 per $1,000 face amount, to 98 3/4.

Two-year note yields were at 0.71 percent after falling Friday to 0.68 percent, the lowest in almost three months. A quarter-point rate increase would push the Fed’s target range to 0.5-0.75 percent, with the upper end climbing past the two-year yield, Gross said.

“I don’t think it’s appropriately priced,” he said.

Gross had earlier been premature in calling an end to a global bond rally. “Developed market yields have bottomed,” he wrote on Twitter on March 10. The yield on the Bloomberg Global Developed Sovereign Bond Index has fallen to 0.65 percent from 0.79 percent on the day of the comment. Chicago Fed President Charles Evans said at an event in London on Monday that the central bank’s “wait-and-see” stance was appropriate and that he’d like to have more confidence in the outlook for inflation. At the same time, he said U.S. economic fundamentals are “good” and that the labor market has been strong for a while.

Dudley, his New York counterpart, said in an interview with the New York Times on May 6 that it’s reasonable to expect two moves this year. The interview was published on the newspaper’s website following the release of the payrolls report.

Relatively calm financial markets and a weaker dollar will make it easier for policy makers to act, El-Erian said on Bloomberg TV on May 6. “I do think they’ll hike at least once, and they could hike twice this year,” he said.

Pimco’s Kiesel said the labor market is gradually improving. “They’ll probably start with one or two hikes by the end of the year,” he said on Bloomberg TV May 6.

The odds of a rate increase in June are about 8 percent, rising to 53 percent for a move by year-end, according to data based on fed fund futures compiled by Bloomberg.

Not Priced

As for the Treasuries market, “the risk is that the market needs to correct at some point,” said Allan von Mehren, chief analyst at Danske Bank A/S in Copenhagen.

“Only very little is priced for this year and even one hike is not fully priced,” he said. “Lower risk sentiment at the moment is also supporting fixed income. The market will generally trade cautiously and be hesitant to price in too much at a time. But a 20-to-25-basis-point increase in two-year yields is likely ahead of the next Fed hike. Back to around 1 percent over the summer.”

— Check out Has Bill Gross Turned Socialist? on ThinkAdvisor.


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