Bloomberg News

Gross Says Credit Expansion to Create Inflation, Slow Growth

March 27, 2012

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said continued credit expansion by central banks will produce accelerating global inflation and slower growth.

Pimco favors shorter duration and inflation-protected debt, as well as dividend-paying stocks with a preference for developing markets, Gross said in his monthly investment outlook posted on the Newport Beach, California-based company’s website today.

“When interest rates cannot be dramatically lowered further or risk spreads significantly compressed, the momentum begins to shift, not necessarily suddenly, but gradually yields moving higher and spreads stabilizing or moving slightly wider,” Gross, the founder of Pimco, wrote. “In such a mildly reflationary world, unless you want to earn an inflation- adjusted return of minus 2 percent to 3 percent as offered by Treasury bills, then you must take risk in some form.”

The zero-bound interest rate policies of global central banks including the Federal Reserve have caused investors to face “financial repression” that reduces future returns on all financial assets. Gross said the Fed’s easy money policy, including expansion of its balance sheet through debt purchases, raised the risk of future inflation cutting into bond returns.

The Fed purchased $2.3 trillion of debt in two rounds of s- called quantitative easing that have become known as QE1 and QE2 as part of its efforts to support the world’s biggest economy. Policy makers in January said they plan to keep their benchmark interest rate near zero until at least the end of 2014.

‘Mildly Reflation’

The Fed is “likely to hint” at QE3 at its April 25 gathering, Gross wrote on a Twitter posting earlier this week. Gross serve as co-chief investment officer with Pimco Chief Executive Officer Mohamed El-Erian.

“In such a mildly reflation world where inflation itself remains above 2 percent and in most cases moves higher, delivering double-digit or even 7 to 8 percent total returns from bonds, stocks and real estate becomes problematic and certainly difficult,” Gross wrote. “Real growth as opposed to financial wizardry becomes predominant. Commodities and real assets become ascendant. Financial assets cannot be elevated by zero-based interest rate or other tried but now tired policy maneuvers that bring future wealth forward.”

Central bank policy makers upgraded the outlook for the U.S. economy at their March 13 meeting, while they reiterated their pledge to keep interest rates near zero until at least late 2014.

Market Performance

Pimco’s $252 billion Total Return Fund reduced holdings of Treasuries last month for the first time since February 2011, when it cut its stake in the securities to zero.

Gross lowered the proportion of U.S. government securities in the fund to 37 percent of assets from 38 percent in January, according to a report on the company’s website. He raised mortgages to 52 from 50 percent.

The Total Return Fund earned 2.5 percent for investors this year, beating about 96 percent of its competitors, according to data compiled by Bloomberg. The fund has lost 0.09 percent over one month, topping 66 percent of rivals, the data shows.

Pimco, a unit of the Munich-based insurer Allianz SE, managed $1.35 trillion of assets as of September.

Russian Debt

The five-year notes that Russia plans to sell offer more value than U.S. Treasuries of the same maturity, Gross said in an CNBC interview today.

While Pimco said 10 years ago that it wouldn’t buy Russian debt, the risk is now offset by the reward of the higher yields, Gross said. He still is concerned about the rule of law in Russia, Gross said in the televised interview.

Russia may sell $3 billion of dollar-denominated bonds due in 2042, which may be priced to yield between 250 and 255 basis points more than Treasuries, according to a banker with knowledge of the deal, who declined to be identified because the transaction isn’t public yet. The Finance Ministry is also offering $2 billion of five-year notes at 230 to 235 basis points over Treasuries and $2 billion in 10-year debt at a spread from 240 to 245 basis points, or 2.45 percentage points, the banker said.

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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