Tags: Gross | Fed | Treasury | Bubble

Gross: Fed Hot Air Will Keep Treasury Bubble Aloft

Sunday, 23 Dec 2012 03:35 PM

Short-term Treasury notes will remain inflated in price thanks to the Federal Reserve's continued liquidity injections, said Bill Gross, founder of Pimco, manager of the world's largest bond fund.

To spur recovery, the Federal Reserve has slashed interest rates to near zero and has also carried out multiple rounds of quantitative easing.

Under quantitative easing, the Fed buys bonds such as Treasurys or mortgage debt held by banks, pumping the financial system full of liquidity in the process to make sure borrowing costs stay low across the economy.

Editor's Note: The Truth About the Economy — Government Documents Lead to Eerie Conclusion

The Fed is currently running a round of quantitative easing in which it buys $85 billion in mortgage-backed securities and Treasury holdings a month from banks on an open-ended basis.

Since the Fed has said loose policies will stick around for a while, expect the U.S. central bank to continue snapping up Treasury instruments, keeping their already lofty prices afloat.

"Of course there is" a bubble in the bond market, Gross told The Daily Ticker.

"[But] I don't think rates are going to go much higher...the Fed is blowing lots of air — some say hot — and constantly inflating the bubble."

Side effects to quantitative easing include mounting inflationary pressures, which should steer investors away from longer-term Treasury bonds.

"Ultimately, over time, not necessarily in next three to six months, [quantitative easing] creates an inflationary impact," said Gross.

"That suggests investors be leery of long-term bonds which are sensitive to long-term inflation and to be more focused in intermediate and front-end [bonds] with some confidence. Yields will not go much higher simply because the Fed is in there blowing hot air."

Other Pimco officials agree, including Mohamed El-Erian, CEO of the fund giant and co-chief investment officer of the fund, who says Fed action will pump up shorter-duration Treasurys.

"The front end will be more stable anchored both by purchases by the Fed and the [policy statement] language about keeping interest rates at zero," El-Erian told CNBC.

"The long end is going to be more volatile and more dangerous, so it depends where on the curve you look."

Investors worldwide should also resist the urge to bet against stimulus measures taking place at their central banks, as massive liquidity injections and rate cuts can send asset classes like stocks rising and longer-term bonds falling despite other influences, he said.

Editor's Note: The Truth About the Economy — Government Documents Lead to Eerie Conclusion

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