|Founded in 1971 by Bill Gross, with $12 million in assets under management, PIMCO - - Pacific Investment Management Company - - today it is the biggest bond fund manager with about $756 billion in assets. In 2000, PIMCO was acquired by German insurance giant Allianz..
Bill Gross, the founder of multi-billion bond fund manager PIMCO, begins his June investment outlook with the famous quote from the French writer Honoré de Balzac: "“Behind every great fortune lies a great crime.” He ends with a quote from the American Depression-era comedian Will Rogers, at whose shrine I once paid homage, on Cheyenne Mountain, Colorado Springs. In between, Gross says it is probable that US trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as America used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets.
Bill Gross writes that the US annual deficit of nearly $1.5 trillion is 10% of GDP alone, a number never approached since the 1930s Depression. While policymakers, including the President and Treasury Secretary Geithner, assure voters and financial markets alike that such a path is unsustainable and that a return to fiscal conservatism is just around the recovery’s corner, it is hard to comprehend exactly how that more balanced rabbit can be pulled out of Washington’s hat. He says private sector deleveraging, reregulation and reduced consumption all argue for a real growth rate in the US that requires a government checkbook for years to come just to keep its head above the 1% required to stabilise unemployment. Five more years of those 10% of GDP deficits will quickly raise America’s debt to GDP level to over 100%, a level that the rating services – and more importantly the markets – recognize as a point of no return. At 100% debt to GDP, the interest on the debt might amount to 5% or 6% of annual output alone, and it quickly compounds
Gross says the immediate question is who is going to buy all of this debt? Estimates suggest gross Treasury issuance of up to $3 trillion this calendar year and net offerings close to $2 trillion – almost four times last year’s supply. Prior to 2009, it was enough to count on the recycling of the U.S. trade/current account deficit to fund Treasury borrowing requirements. Now, however, with that amount approximating only $500 billion, it is obvious that the Chinese and other surplus nations cannot fund the deficit even if they were fully on board – which they are not. Someone else has got to write checks for up to $1.5 trillion additional Treasury notes and bonds.
Bill Gross says the concern is that this can be accomplished in only two ways – both of which have serious consequences for US and global financial markets. The first and most recent development is the steepening of the US Treasury yield curve and the rise of intermediate and long-term bond yields. While the Treasury can easily afford the higher interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a serious threat to the fragile “green shoots” recovery now underway. Secondly, the buyer of last resort in recent months has become the Federal Reserve, with its publically announced and near daily purchases of Treasuries and Agencies at a $400 billion annual rate. That in combination with a buy ticket for over $1 trillion of Agency mortgages has been the primary reason why capital markets – both corporate bonds and stocks – are behaving so well.
Gross says all investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago. Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early 30s that he wasn’t as much concerned about the return on his money as the return of his money.
PIMCO CEO Mohamed El-Erian, said last week that markets are also starting to realise that the speed limit for sustainable US economic growth is coming down as credit contracts, saving behaviour changes, and regulation increases. Put all this together and you come to a simple conclusion: inflationary pressures will take hold well before what would be expected based on recent historical experience based on "output gap" analyses.