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Bill Gross co-founder of PIMCO and manager of the worlds largest bond fund, told delegates at the Morningstar Investment Conference in Chicago. That the Fed has got it wrong if it thinks interest rates are going to stabilize at 2 percent.
“Policy rates have always provided a fundamental foundation for asset prices, and if the Federal Reserve is right in looking for real policy rates to stabilize around 2 percent, markets could be headed for trouble, Gross said on Thursday.”
A more reasonable projection would be for real policy rates to stabilize around zero, from the -1.25 percent levels they are today, according to Gross. Which coincidentally is in line with Pimco’s ‘new neutral’ market mantra.
“In a highly levered economy, a 2 percent real rate is far too high,” Gross told an audience of about 2,000 financial professionals. “If the new neutral is closer to zero, then asset prices are less bubbly. They can survive at these rate levels, but they can’t survive at 2 percent.”
Gross’s ‘new neutral’ is marked by exceedingly low real policy rates for the next three to five years, which will mean only modest return potential for most investors. During that period, the global economy should not show signs of serious recovery, but should by and large find stability amid sluggish growth.
“The new neutral is a critical idea for investors and central bankers, and I would say that the new neutral is the most significant element in asset pricing today or in the past,” Gross said. “If the new neutral is closer to zero, we have a market where you can take measured risk, and earn not a decent return, but a return that’s positive and relatively less volatile.”
The real challenge is that no one really knows where rates are going, and investors have to make choices for their portfolio now. Those choices should be centered on an awareness of quantitative easing and the end of it in the U.S. as a policy choice, as well as a focus on the long-term yield curve going forward. It wouldn’t hurt to have a preference for exposure to interest rate and credit spreads rather than duration at this point, Gross said.
You can read the full transcript of Gross’s speech at ETF.com.
Todays Other Top Stories
LearnBonds: – FOMC outlook seems consistent with moderate economic growth. – Paying attention to Ms. Yellen’s comments is like driving by looking out your windshield. Paying attention to only the FOMC statement is like driving with only your rearview and side view mirrors. Paying attention to the Fed’s “dots” is like looking ahead via radar. Our advice is to use all three tools when assessing potential future monetary policy conditions.
MSN Money: – Puerto Rico public workers fight budget law, bond yields spike. – Some Puerto Rico government workers are threatening to walk off their jobs over a newly enacted budget law, adding to a recent financial whirlwind that is sending yields on the territory’s junk bonds to record highs.
Muninet Guide: – Municipals at Another Interesting Juncture. – As we head into the mid-year mark, the municipal market has once again proven its resilience with a head-turning rebound coming on the heels of a disastrous 2013.
Reuters: – UBS faces criminal probe for Puerto Rico bond fund sales – lawyers. – U.S. authorities are probing UBS AG for criminal fraud after a former broker in Puerto Rico allegedly directed clients to improperly borrow money to buy mutual funds that later plunged, according to lawyers representing some of the investors.
Bloomberg: – Supply doldrums end in Citigroup $330 billion call: Muni credit. – The supply slump that’s fueling the best run for municipal debt since 2009 is poised to end next year as governments ramp up borrowing for long-delayed projects from water to transportation, Citigroup Inc. (C) predicts.
Bloomberg: – Supply doldrums end in Citigroup $330 billion call: Muni Credit. – The supply slump that’s fueling the best run for municipal debt since 2009 is poised to end next year as governments ramp up borrowing for long-delayed projects from water to transportation, Citigroup Inc. (C) predicts.
Bloomberg: – Muni Supply Set for Second Weekly Drop as Yields Near 1-Year Low. – Issuance in the $3.7 trillion municipal-bond market is set to slow next week, helping keep benchmark yields close to one-year lows.
WSJ: – SEC Chairman unveils plan to boost transparency in bond markets. – The nation’s top securities regulator, weeks after disclosing a sweeping plan to address issues in the stock market, is targeting a new corner of the market for reform: the bond market.
MoneyNews: – Investors dump bonds as Treasury sells inflation-protected TIPS. – Treasury 30-year bonds fell the most in three months on Thursday as the department auctioned inflation-protected securities.
WSJ: – Treasury bonds pull back on inflation fears. – Treasury bonds pulled back Friday as some investors started to worry that the Federal Reserve may fall behind in curbing the risk of higher inflation.
Income Intelligence: – Singing in the Rain: Investment grade corporate bonds have hit all the right notes. – Investment grade (IG) corporate bonds have had a stellar year. With returns running close to 5% in just the past five months, it’s a natural time for investors to ask the question, is something going to give?
Reuters: – Corporate bond boost to combat lean pickings at banks. – Buoyant debt capital markets are expected to provide a welcome shot in the arm for investment banks over coming years, with Standard & Poor’s predicting that non-financial companies could issue as much as US$6.6trn of bonds over the next four years, providing banks with billions in fees.
High Yield Bonds
Businessweek: – Valeant’s $12 billion junk bonds would be No. 2 offering. – Valeant Pharmaceuticals International Inc. (VRX:US)’s proposed $12 billion junk-bond offering to fund its attempted hostile takeover of Allergan Inc. would be the second-biggest on record behind billionaire Patrick Drahi’s $17 billion sale in April.
FT Portfolios: – High yield corporate bond yields reach historical lows. – Yesterday’s release from the Federal Reserve noted that Fed members had raised their forecast for the federal funds target rate at the end of 2015 from 1.00% to 1.00-1.25%, and its 2016 target from 2.25% to 2.50%. This is significant because it provides investors with some additional guidance.
Wells Fargo Blog: – Is high yield overvalued? – It has become a standing joke in the media that we can no longer call junk bonds high-yield bonds because the yields are too low. More serious commentaries suggest that after a five-year rally, the high-yield market has become substantially overvalued and, therefore, it is no longer an appropriate investment category for most individual investors. This point of view looks at the overvaluation question and concludes that a more conservative approach to credit risk might now be warranted.
S&P Capital IQ: – High yield bond funds see first cash withdrawal in 7 weeks, thanks to ETFs. – Retail-cash outflows for high-yield funds totaled $239 million in the week ended June 18, according to Lipper. The outflow is the first negative reading in seven weeks and it’s almost entirely due to withdrawals from the exchange-traded fund segment, at $231 million, or 97% of the outflow.
News on Invest: – Argentina dispute fails to deter investors. – Argentina stands on the brink of default, engaged in one of the ugliest fights ever witnessed between a country and its creditors. Yet this week’s ruling in the case dubbed the sovereign debt trial of the century has done little to spoil investor appetite for risky government debt.
Wealth Manager: – Why T Rowe Price is buying back into Russian corporate debt. – Michael Conelius, emerging market debt portfolio manager at T Rowe Price, has bought into debt of selected domestic-oriented Russian companies as expectations of further sanctions against the country have ‘greatly diminished’.
Citywire Global: – MainFirst launches EM credit opportunities fund. – MainFirst Asset Management has launched a second bond fund aimed at emerging market corporates, Citywire Global has learned.
FT: – Re-emerging markets offer opportunities. – Investors who backed China and India over the past ten years made much more money than investors in the main advanced markets. Over the past two years it has been much better to back the higher income countries. Could this be about to change?
CNBC: – ETFs for investors who need bond income. – A decade ago, investors were still trying to figure out how to use the first bond ETFs. Three iShares Treasury ETFs and one iShares investment-grade ETF launched in July 2002. Now there are more than 265 bond ETFs and assets exceed $275 billion.
Cincinnati.com: – SimplyMoney: Prepare for bonds to change course. – For almost 30 years, interest rates have declined, as witnessed with mortgages, CDs and saving accounts. Newer bonds paid less interest than older bonds and were thus less attractive in the marketplace. Investors wanted the older, better-paying bonds, which drove up their prices. Investors need to recognize the reverse is soon to happen.
Wall St Daily: – High-yielding PIMCO funds to sell right now. – Forget the Total Return Fund, though. Investors in two other PIMCO funds should be heading for the exits, instead. But they’re not… just yet.
Fox Business: – What Financial assets did the Fed give the ‘OK’ to buy on Wednesday? – The future of the Fed Funds rate is now one of the most important, if not the most important factor in accessing financial asset values as we enter the 6th year of post crisis investing.
Invest Yourself: – My income portfolio update: Exchanging a high-yield ETF for a solid-yield REIT. – High-yield bonds have been a part of my portfolio for quite a few years now. Over time, their diminishing yield has made me scrutinize at just what level they become less appealing to me.
Morningstar: – Handling mutual fund bloat. – An actively managed fund can become too large for managers to effectively oversee.
I'm now of the opinion that the Fed should stop reinvesting runoff after the taper to reduce the balance sheet. Think rate hike a ways off.
— David Schawel (@DavidSchawel) June 20, 2014
SEC White says fixed income markets lag way behind equities. Where is technology?Systems are BD inventory based and not transformative yet.
— Joseph S. Fichera (@josephfichera) June 20, 2014
RT: @cpb24 JPM HY Index at 5.14% is just 10bps off the May '13 all time tight w 5Y UST is 105bps wider over the same time. Wild. En Feugo
— David Schawel (@DavidSchawel) June 20, 2014