Pimco's Gross Says Fed Will Slash Rates to 4.25% (Update4)
By Elizabeth Stanton and Chris Cooper
Jan. 5 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund, says the Federal Reserve will lower its benchmark interest rate by a percentage point to 4.25 percent this year to support economic growth. The Fed will start cutting its target for the overnight lending rate between banks in the first half as the economy slows, he said. The nominal growth rate, unadjusted for inflation, was 3.8 percent during the third quarter, compared with 5.9 percent in the second quarter.
``Slower economic growth, certainly slower nominal growth, ultimately forces the Fed to lower'' the cost of funds, Gross, chief investment officer at Pacific Investment Management Co., said in an interview. The rate may be cut to ``below the nominal growth rate in order to re-stimulate assets and re-stimulate productive growth in the economy.''
Ten-year U.S. Treasury note yields will fall to about 4.50 percent, Gross wrote in a report published on his firm's Web site yesterday. The 10-year yield, 4.60 percent at 5:08 p.m. in Tokyo, has risen in the past two years. The Newport Beach, California-based firm, a unit of Munich- based Allianz SE, oversees $642 billion, including the $100 billion Pimco Total Return Fund. So-called nominal growth in U.S. gross domestic product of 4 percent ``is not enough to support an asset-based economy which has built-in costs of debt averaging 5 percent plus,'' Gross wrote in the report.
With a decline to 4.50 percent yield at year-end the 10-year note would return about 5.4 percent, according to data compiled by Bloomberg. It would be the biggest gain since it returned about 15 percent in 2002, according to index data compiled by Merrill Lynch & Co.
GDP and Fed
On three occasions in the past 15 years when the growth rate of nominal GDP dropped at least a percentage point below the Fed's benchmark, stock prices or housing prices or both declined, and the central bank subsequently lowered the target to at least a percentage point below the growth rate to blunt the damage to the economy, according to Gross. The median price of an existing home fell from a year earlier in November, the fourth consecutive monthly drop.
The Fed raised its target for the federal funds rate in quarter-point increments at 17 straight meetings from June 2004 to June 2006. Gross underestimated how much the Fed would raise rates in the past two years and when it would stop. In June 2005, he predicted the increases would stop at 3.5 percent. In May, he predicted 5 percent was the limit.
Fund Holdings
Gross has boosted the Total Return Fund's holdings of debt maturing in three years or less, which typically benefit most from Fed rate cuts. Cash equivalents including debt maturing in less than a year accounted for 47 percent of its interest-rate risk as of Nov. 30, the firm said on its Web site. That is the biggest share the fund has reported in six years of data. Debt maturing in one to three years accounted for 24 percent of the fund's interest-rate risk, or duration, up from 19 percent in October and the most since August 2005. Gross's fund advanced 4 percent last year, outperforming 55 percent of its competitors, according to Morningstar. It returned 5.65 percent on average in each of the past five years, beating 89 percent of its peers.
(c) Bloomberg L.P.
Last Updated: January 5, 2007 03:12 EST
