Bill Gross: Talk of Rate Hikes is 'Comical'

Yahoo!Finance is reporting Fed Can't Raise Rates.

The Federal Reserve's decision to hold the line on interest rates was the only move the central bank could make considering the state of the US economy, PIMCO chief Bill Gross said on CNBC.

Reacting to the Fed's move to hold its key interest rate at 2 percent, Gross called talk of rate hikes "comical."

"We're in a recession. When has the Fed ever raised rates in a recession?" he said. "Unemployment is headed toward 6 percent, mortgage rates on home buyers are at 7 percent, and these guys want to raise rates?"

My Comment: I often disagree with Gross, but this is extremely easy to follow logic that I am 100% in agreement with. The Fed is not hiking. 

Gross said the central bank has a responsibility now to provide liquidity.

"We're in an asset deflation of near-historic proportions. That calls for the use of the government's balance sheet and not for the Federal Reserve to raise interest rates," he said. "To the extent that the central banks now must prevent that deflation, interest rates don't go up, they go down."

My Comment: In the US, the only asset deflation of historic proportion we are seeing is in housing. However, commercial real estate is coming, as is equity deflation.

In parts of the world (China and India for example) an equity crash of historic proportions is indeed underway. And to top it off credit risk is soaring in spite of the Fed's historic efforts to increase liquidity.

With this backdrop, screams of inflation are ridiculous. 

"In the US, 2 percent is pretty much the floor. I think the Fed made that clear," he said. "They're going to provide liquidity in different forms and fashions."

As for investments at this point in the market, Gross advised against junk bonds and toward government-backed securities.

My Comment: It remains to be seen if 2% is the floor or not. I doubt it. Restraints on the Fed will also be lifted depending on what the dollar and commodities do. Actions of foreign central; bankers also come into play. Finally, things also depend on whether or not the Fed gets authority to pay interest on reserves.

The statement about providing liquidity in other fashions is certainly true as witnessed by an alphabet soup of lending facilities (TAF, PDCF, TSLF)which have now been extended.

Gross's advice against junk bond is rock solid. Junk will get hammered as default risk rises. 

"We want to stay under the umbrella to the extent that we have an umbrella that shelters large banks and to the extent that we have an umbrella that shelters the agencies, Fannie (FNM) and Freddie (FRE), that's where you want to be," he said. "Why mess with junk bonds? Let's stick to high quality and stay under that umbrella. Let's stay dry."

My Comment: Gross made his bet, and that bet was that Fannie and Freddie would be bailed out at taxpayer expense. That bailout has been estimated at $25 billion. $250 billion might be closer. One does not have to like it (I sure don't) but it is what it is.

Point by point I agree with Gross. What I frequently disagree with Gross about are his proposed solutions, such as but not limited to, bailing out Fannie Mae.

Comments

[Larry House:]

Good info here. Safety trumps return at this point. We haven't yet seen the worst of this cycle; hold on to your hat and raise cash!

2008 Aug 06 12:08 PM

[JasonC:]

"the only asset deflation of historic proportion we are seeing is in housing"

Nonsense. Housing is down by trillions, stock is off by a trillion, commercial paper collapsed half a trillion just last year, subprime paper is gone, poof, asset back markets generally have taken huge haircuts and seized, student loans cannot be made on commercial terms. And now commodity markets and primary producers are crashing, too, the last to notice that it isn't an inflation but a deflation.

Everyone pretends it must be inflation because gas is $4. With gas at $4 there is no demand, because it isn't more dollars chasing the same number of goods. M1 hasn't moved in 3 1/2 years. Housing prices have fallen by more than enough to outweigh the impact of gas, since housing is a huge part of everyone's costs and gas is a trivial portion of them. But since so many people are long houses and so few are long oil, we aren't supposed to notice that prices as such, include both.

If it were as normal to own 5 oil futures as a house, nobody would be confused about this stuff. Everyone is responsible for their own choice of asset position.

2008 Aug 06 12:13 PM

[Chris1:]

Of course by keeping money cheap it help create the other monkey on our back; commodity inflation and a weak dollar.

The problem with Keynesian cycles is that they are long. We can't let housing truly correct without ending the banking system as it exists so the only solution is inflation. If you drive rents higher it would create a floor on RE property.

Trouble right now is predicting a bottom with the huge inventory that sort out quickly enough. I've tried a short sale with FNM, about a six month process. Auctions are often a scam as well, there is a bottom offer from the loan holder and it looks like there are too many incentives to grow more inventories. Where is the next generation of home buyers and why would they accept the commonly accepted level of current real estate? It will only happen when rents become much less attractive than owning.

2008 Aug 06 12:20 PM

[User 68127:]

Bill Gross is "comical." However, we do seem to be inching closer to his forecast of 5000 on the Dow made about 4000 points lower than current levels!

As usual he is talking his own positions. If he knows that the government is going to bail Fannie and Freddie due to the size and connections that his firm has, or its hiring of Greenspan, then more power to him. Just don't call him a great investor. He is gaming the political system at the expense of the little guy.

2008 Aug 06 12:41 PM

[User 68127:]

Raising rates in a recession? It all depends upon your starting point. If you recall that the Fed started cutting last fall at 5.25%, then short rates could easily go higher while still being below that level.

Snugging up the short rate might help contain inflation, benefit the dollar and further ease pressure from high energy prices.

Furthermore, there is a credit crunch. That mean loans are NOT AVAILABLE at low rates to consumers and businesses, if at all. Since no lending is occurrring at 2% anyway, what does it hurt to bump it up to a realistic market rate? It only hurts the big money cronies at the I-banks and commercial banks, which is why it is not being done. The benefit of low rates is being "privatized" while the detrimental effect--rising food and commodity prices--is being socialized.

2008 Aug 06 12:50 PM

[flow5:]

The answer is the same as in 1966 where REG Q ceilings for the commercial banks were lowered, but not for the financial intermediaries (S&Ls).

The savings-investment process is an abstract reality that conceptually is unfathomable to the unthinking (Just as Einstein’s early papers were).

People are just arrogant and thus ignorant. Just remember what Louis Stone said in the Wall Street Journal (whom the movie Wall Street was dedicated).

2008 Aug 07 11:42 AM

[carey_jim:]

Even more (tragi-)comical was the 300 point move up in the stock market the other day and other bear shenanigans.

Apparently the housing sector is booming also :)

Who said a recession has to be depressing?

2008 Aug 07 12:07 PM

[dieuwer:]

US 2008 = Japan 1998. Rates will see 0% before 2.25%.

2008 Aug 09 05:42 PM