Don’t count on the Federal Reserve to raise interest rates any time soon, says Bill Gross.
The bond fund manager expects the Fed to leave its key federal funds rate at 2 percent for the rest of the year.
At its June 25 meeting, the Federal Open Market Committee (FOMC) decided against a rate change, after trimming the Fed funds rate at every meeting since September. The easing totaled 3.25 percentage points.
Now, “The Fed is at neutral, where I think it should be,” Gross, CEO of PIMCO, told CNBC in a recent interview.
“The language in this statement and this debate has all the makings of a future Nobel Prize,” says Gross, referring to the statement that accompanied the June 25 FOMC decision in which the Fed discussed the risk both of slowing economic growth and rising inflation — stagflation.
“The real question is whether the central bank can bring down commodity prices by raising short-term interest rates,” Gross says.
Some Fed officials have focused their concern on rising inflation in recent speeches, and one FOMC member, Dallas Fed Bank President Richard Fisher, dissented from the June 25 decision and argued for a rate hike.
Consumer prices rose 4.2 percent in the year through May. The S&P GSCI Commodity index rose 68 percent during the same period.
“The prior orthodoxy stressed the tradeoff between unemployment and inflation — the old Phillips curve,” Gross says.
“Now we have a debate about a new tradeoff.” Gross says that new tradeoff is how to bring down inflation without sending the economy into a tailspin. “The one that solves this puzzle can claim a piece of history,” he says.
Gross says the Fed is right to stand pat because the U.S. economic slowdown will naturally push inflation lower.
“I think the Fed does know that excess capacity will lower inflation during a period of economic slack,” he says. “That’s what we’re going to have for the next 12-18 months in my opinion, and I think the Fed recognizes that too.”
Housing and some other asset prices, of course, already are dropping. Given his view that other prices will fall soon too, Gross says, “That means that the Fed funds level at 2 percent is certainly neutral and may not even be stimulative in terms of our significant asset deflation.”
The credit crisis isn’t over yet, Gross maintains, so both the economy and financial markets could be in for rocky times ahead. “There’s still a lot of stress in the financial markets,” he says.
“There’s still a lot of leverage to be unwound. The U.S. economy and even the global economy is de-leveraging, and when an economy de-leverages, there are substantial problems and substantial risks.”
Already, economic growth averaged only a 0.8 percent annual rate in the six months through March. Meanwhile, financial institutions have suffered about $400 billion of losses and write-downs thanks to the credit crunch.
“We’ve seen write-offs in the hundreds of billions of dollars, with more to come,” Gross says. “There’s a lot of tenuous action in the financial markets these days, and I expect more of it.”
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