Bill Gross of Janus Capital spoke with Bloomberg’s Tom Keene and Michael McKee on Bloomberg Radio and Television this morning to respond to today’s jobs report.
Gross said there is a “100 percent chance” the Fed will raise interest rates in December after jobs surged. “They’re ready to go.” He said: “100 percent that they go in December and then try and tamp it down with mild, gradual language that will keep the dollar from strengthening even further.”
On dollar strength, Gross said: “I think the Fed fears it…They took it out of their statement last month. But prior to that, they were cognizant of the fact that a very strong dollar has negative implications for emerging markets… It’s certainly a negative for the global financial system because there are many bets and much dollar denominated debt in terms of emerging market corporations and sovereigns will be impacted by this.”
On gold, Gross said: “Gold is a mystery, we all know that, but to the extent that real yields rise, it’s a negative impact for a gold price because it makes it more expensive relative to other alternatives. So that’s one explanation. I can’t give you the total solution for why gold goes up or down.”
TOM KEENE: Bill Gross will be glued to his Bloomberg, won’t he?
MICHAEL MCKEE: He is glued to his Bloomberg. He is glued to our phone line now.
Bill Gross is joining us now from Janus Capital out in California. Bill, son not even up there, yet, but I’m sure there is a bright glow emanating from 20th and C Streets in Washington that you can see from there.
BILL GROSS: Well, I think so. And I’m glued to six of my Bloombergs and they’re all telling the same story, that it’s almost 100 percent that the yellow light changes in December to bright green.
Before going to bed last night, I calculated that any jobs number over 150,000 would be sufficient. And I think importantly because the Fed views the economy and future inflation through a Taylor Rule and a Phillips curve lens that speaks to low unemployment and a new NARU that somewhere around 5.25 percent, which is now below that at five percent.
KEENE: Right.
GROSS: And so I think they’re ready to go.
KEENE: Bill, they recalibrate. What are they waiting for?
Why not have a special meeting and say this was extraordinary and get out front and provide the leadership that the market is desiring?
GROSS: Well, because that’s not the nature of the current Fed. I think we would agree with that, Tom. They’re gradual and they want to make sure that markets are prepared. And unlike Volcker who at one point in the late 1970s shocked the market with a two percent increase before telling anybody, I don’t think that’s the nature of this Fed.
But I think the market obviously is anticipating a rather quick increase of 25 basis points as evidenced by the rise in the two year to 91 basis points.
KEENE: I want Mike McKee to get back to the jobs report, Bill Gross. But I believe this is yields higher, bond prices down. How do you adjust in an unconstrained manner this morning?
GROSS: Well, hopefully you go into it as we did at Janus with a negative duration. That’s the nature of unconstrained. And the beauty of it to prepare for a mild bear market I suppose. There is certainly a down day in prices like today.
And so, yes, earlier this week negative durations going short. The 30 year treasury as opposed to long, and obviously making money at the moment.
MCKEE: Well, here’s what I want to ask you, Bill. The Fed is going to raise interest rates likely in December. The whole goal of QE was to move investors out the risk curve, move you longer. You’re coming back in.
If everybody is doing that, how does that affect the curve, and how does that affect liquidity in the markets if everybody reverses a seven year trade right away?
GROSS: Well, I think that’s a potential problem, yes. And I think since before the data the chances in the market of a December hike was about 60 percent or so. I think today’s report is going to tilt investors towards the reality of a Fed increase in rates for the first time since 2004.
I think you mentioned that previously Mike and Tom, nine years ago was the first time they increased rates.
KEENE: Right.
GROSS: And although the Fed has prepared markets for this, I think the markets may not be prepared because hedge funds and even retail investors will look at this headline and use ETFs and maybe even mutual funds as an exit vehicle.
KEENE: Right.
GROSS: And they all can’t get out at the same time. So it will be interesting to see today and obviously early next week in terms of how quickly they want to hit the exits.
KEENE: Bill Gross with us right now with Janus Capital. We welcome all of you on Bloomberg Radio and Bloomberg Television worldwide.
Bill, I look at the compensating factors and where you know you see that is the deepest market, foreign exchange. Euro 107; the yen blows out to almost a 123, 122.77. What does that dollar strength signal to you?
Is that a construct for the U.S. economy? Or is dollar strength something American manufacturing has to fear?
GROSS: Well, I think so. And I think the Fed fears it, too. They took it out of their statement last month. But prior to that, they were cognizant of the fact that a very strong dollar has negative implications for emerging markets.
I mean I look at the Mexican peso at the moment, up by 18 ticks, and that’s 1.25 percent, meaning down 1.25 percent. And so if that’s typical of emerging markets across the world –
KEENE: Yes.
GROSS: – and you spoke to the euro, then the dollar is strong and there are implications in terms of balance sheets for many of these countries.
I think it’s very much of a concern, something the Fed should think about but probably won’t in December.
MCKEE: Well, what could they do about it?
I mean it always comes back to the old John Connolly line about our dollar, your problem. But their mandate is the United States.
GROSS: I agree. And to the extent that the global markets and the recognition that they’re the central bank of the world, which they refuse to acknowledge publicly, is down the list, then inflation and economic growth and wage growth, which we just talked about, become the dominant considerations.
So it’s just a question of priorities.
KEENE: Right.
GROSS: I think they’ll go. And then they’ll look around and see how strong that dollar is. But it’s certainly a negative for the global financial system because there are many bets and much dollar denominated debt in terms of emerging market corporations and sovereigns will be impacted by this.
KEENE: Right. Jason, come on over here with that camera. I’m going to bring Jason over. Bloomberg Radio, I’m going to put this out on Bloomberg Radio Plus right now.
This is gold. Dennis Gartman on earlier about gold. And I’m sorry, Bill Gross, gold itself, what does it signal if gold breaks through to new weakness here below $1,100 the ounce?
GROSS: Well, you know, I look at my fifth Bloomberg screen and I see the real yields on a long term basis are up three or four basis points. And to me – and yes, gold is a mystery, we all know that, but to the extent that real yields rise, it’s a negative impact for a gold price because it makes it more expensive relative to other alternatives.
So that’s one explanation. I can’t give you the total solution for why gold goes up or down.
KEENE: But to financial repression – I mean Bill Gross has been somebody who has said through the decade retirees are going to be hammered in this nation because of the dynamics of the topline nominal yield and the real yield, which is the way we really spend our money.
If yields go up, that doesn’t assume, Bill Gross, that the real yield goes up as well, right?
GROSS: Yes, not necessarily. It could go up because inflation is going up and the Fed holds the line in terms of the new neutral real Fed funds rate. That’s certainly a possibility.
If they raise interest rates by 25 basis points or so in December, that sort of assumes that inflation is moving in the same direction. But, yes, real yields and nominal yields could be entirely different in terms of the Fed posture going forward. But at the moment long term real yields are up by 2.5 basis points.
MCKEE: Quickly before we take a break here. Janet Yellen argued just this week that it doesn’t matter when they raise rates for the first time. What matters is when they stop, how far do they go.
What are you seeing now?
GROSS: Yes, I think that’s critical. And your page FWCM accurately displays the active U.S. treasury curve going forward. And just before 5:30, like John Ryding was saying about half an hour ago, the market was expecting the Fed over the next two years basically to move up by 150 basis points, or just over 75 basis points a year.
That’s far below the green dots in terms of the Fed.
KEENE: Right.
GROSS: And so it’s the market versus the Fed. I have a sense that what I just described in terms of the gradual rate of increase is what is going to happen.
KEENE: Okay.
GROSS: The curve is pretty accurately reflecting what the Fed is going to do.
KEENE: Well, we will come back with Bill Gross of Janus Capital and continue our discussion, particularly on investment for yield.
(BREAK)
KEENE: The two year yield 0.91 percent. Let’s go to your note, Bill, which influenced people worldwide two days ago, “Operation Twist and Shout.” And you say Operation Switch. I’ve yet to meet anyone, Bill, in the professional racket who thinks you can effect what you wrote about.
Why will it be so hard to move treasuries in the long tenure out and buy up the short paper?
Why will this be hard to execute?
GROSS: Well, it would take some time obviously because it took some time to perform Operation Twist, which went just the other way.
But time aside, it makes all the sense in the world to me if, in fact, my premise is correct. And by the way, my premise is being debated by Nobel prize winner Michael Spence and, of course, Larry Summers in the press over the last few weeks on opposite sides. Spence taking basically the side of a positive yield curve.
But, yes, what the Fed can do are two things. One, yes, they can do Operation Switch by taking $2 trillion worth of five plus treasuries and moving it into the short portion of the curve, therefore steepening the curve.
Or second, they can increase their inflation targets, which is what was done in Japan. Both of those would produce a positive yield curve.
And why – why is that important as the Fed begins to tighten? Well, it’s important because history shows that corporate profits are affected by a flattening of the yield curve. And it’s important because capitalism itself cannot survive at a flat yield curve. No investor would invest in a 30 year treasury of the same yield as a 30 year treasury bill.
And so the steeper the curve as the Fed increases interest rates, the better it will be for profits and for the economy itself.
MCKEE: What do we do if this continues, if I mean obviously 271,000 isn’t going to continue, but will we continue to see – if we get down to 4.9 percent, etc., do we get inflation?
And how does the market react to inflation which we haven’t had in so long?
GROSS: Yes, I’m not so sure we get inflation. I mean there are so many variables on the unemployment rate and what the new NARU is and how much excess labor there in the marketplace.
I would point out, looking at a long term Bloomberg chart again, the U.S. employment population ratio 25 to 54 year-olds, which is the age group which really works, it has gone down over the past 15 years from 82 percent and now it’s at 77 percent. It’s an anemic recovery there.
So you can’t tell me that there is not a lot of labor just waiting to come back into the market if the wages were right.
So it’s very much of an uncertain variable and I think the Fed places a lot of importance on this new NARU. But I don’t think that wage inflation is going to be a critical component going forward.
MCKEE: If we have no inflation particularly to worry about, and if we’re no longer – the Fed starts raising interest rates, if we’re no longer pushing people out the curve, then does everybody migrate up?
Do we need to do Twist? Or is the market going to take care of that?
GROSS: Well, to the extent that the market believes itself as opposed to believing the Fed. It’s like a beauty contest, like Keynes said, don’t look at the contestants, look at the judges.
And so I think the market looked at the Fed and, of course, the Fed tries to look at the market and it goes back and forth. But to the extent that the Fed believes in Phillips and believes in the Taylor Rule and believes that over the intermediate term –
KEENE: Right.
GROSS: – which is what the Vice Chairman said two weeks ago, inflation invariably will increase based on higher wages. And, yes, the market will do what the Fed thinks.
KEENE: Bill, you once famously said on this show – I paraphrase – buy Proctor and Gamble. If the ten year yield is at 2.31 percent – that’s right, folks, up seven beeps – and I don’t know where Bill Gross thinks it’s going to go in a year. I’m not going to be rude and ask you. But the basic idea, if you get a three percent ten year yield, where do bond investors hide? Or do they lighten up on bonds dramatically and are they forced into equities?
GROSS: Well, at three percent – and that’s your number, you know –
KEENE: Yes.
GROSS: – I would be lower, but it still indicates –
KEENE: Just as a round number.
GROSS: – higher yields and lower prices. You know, obviously an unconstrained approach where you can go negative duration and make money from it is one approach.
The second approach would be to go where the money is as Willie Sutton famously said back in the ‘30s I guess. And when I say go where the money is, I mean where the QE is.
And that suggests that other central banks, the ECB and the Bank of Japan, are spending hundreds of billions of dollars a year in terms of buying up their markets, but that supports their markets to a relative extent.
I mean German yields are up five basis points today versus the United States, up ten.
KEENE: Yes.
GROSS: And so that’s a defensive type of move even though the yields themselves are obviously less rewarding.
KEENE: I look, Bill, at the portfolio. Let’s talk about your specific portfolio. How are you positioned now?
And how do you adapt in the coming days given what we saw this morning?
GROSS: Well, I would look at this yield at 2.3 percent on the ten year and obviously it’s substantially higher than it was several weeks ago at two percent.
KEENE: Yes.
GROSS: And I’m not turning myself into a permanent bear in terms of yield, so there’s been a significant adjustment. I would believe in the fact that the Fed is going to be gradual and that there is a 50 to 75 basis points a year increase ticked into the market. And I think that’s reasonable.
And so at these levels, I would say that the adjustment is appropriate. And so I’d probably take off a little of that negative duration and be buying some bonds today to sort of flatten it out.
The second thing would be, Tom, that this is a risk off type of statement. I mean stock futures are down six points on the e-munis and spreads on high yield bonds are up by three or four basis points in terms of the CDX. And so when interest rates go up, it becomes more competitive relative to high yield and to stocks.
KEENE: Right.
GROSS: And so it’s a mild risk off type of proposition. So what I would be doing would be to pursue risk off types of trades, meaning don’t invest in stocks to a significant extent. And don’t invest in high yield bonds.
KEENE: Is there any imaginable way that London or Washington can delay given international events?
I mean already as you mentioned peso moves, real moves. We’re not going to get to a 4 real today, but if we see emerging markets more fragile because of impending higher U.S. rates, Janet Yellen, can she ignore that this time around?
GROSS: Probably not. But I think to the extreme, in terms of your thesis, that financial conditions, which is a catch-all for lots of things, but obviously a catch-all for a strong dollar and weak foreign currencies, especially in emerging markets, that should that situation develop that, yes, it will be a consideration and certainly will find its way back into the minutes.
But I think it’s, like I say, 100 percent that they go in December and then try and tamp it down with mild, gradual language that will keep the dollar from strengthening even further.
MCKEE: The markets tend to overreact to everything. And I’m wondering there has been a big question about how far and how fast the Fed goes, but how far and how fast do the markets go?
Do they anticipate 1994 again and move too much ahead of time? Or are they buying yet the Fed’s slow, gradual idea?
GROSS: Yes, I think they are buying the slow and gradual. I’m buying it. And I think they should buy it.
I’ve talked about the new neutral policy rate and I think it’s capped at two percent as opposed to historically it’s slower five percent. And for the most part, that’s built into the yield curve in the United States.
And so there shouldn’t be fear and trembling from this type of approach. It does suggest financial repression for a long, long time. That’s not good for savers, but at least to a certain extent it benefits insurance companies here and pension funds and the small saver than can finally put some money on their savings.
KEENE: More than generous with your time. Bill Gross, thank you so much this morning, with Janus Capital and his unconstrained bond fund.
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