Tags: Pimco | El-Erian | Fed | Outlook | European | Bailout

Pimco's El-Erian: Fed to Cut Outlook as European Bailout Falters

Monday, 20 September 2010 06:57 AM

The Federal Reserve will cut its growth forecasts and Europe’s economic bailout is failing, said Mohamed A. El-Erian, chief executive at Pacific Investment Management Co., which runs the world’s biggest bond fund.

U.S. central bankers may wait beyond their meeting tomorrow to announce additional steps to sustain the expansion, El-Erian wrote in an opinion piece on Pimco’s website. Slower-than-expected economic growth has fueled speculation the Fed will expand its program of Treasury purchases as it tries to keep borrowing costs low. Industrialized nations are eager to let their currencies weaken to aid their economies, he said.

The Fed will signal new easing measures, “but probably not at this meeting,” wrote El-Erian, who is based in Newport Beach, California. “It should and, I suspect, will,” reduce its growth projections.

Fed Chairman Ben S. Bernanke may need time to decide if additional stimulus is needed to support a rebound in growth, say economists surveyed by Bloomberg News. Economic woes are spreading to Europe, where Irish bonds led declines last week by the debt of so-called peripheral euro-region countries on concern the nation’s banks will require further government aid.

The Fed will affirm its pledge to keep interest rates low for an “extended period” and maintain the floor on its holdings of securities, say economists surveyed by Bloomberg News before the meeting tomorrow.

Europe Concerns

Concerns about Europe’s solvency are intensifying, pushing up risk measures for Greece, Ireland, Portugal and Spain to “at or near danger levels,” El-Erian wrote in his piece, which was first published yesterday on ft.com’s ftalphaville website section. “The failure to reduce risk spreads means that the public sector bailout is not working.”

Contracts insuring against default on Ireland have climbed to 422 basis points, according to data-provider CMA, the most since the data started in 2008. The figure is almost 10 times the cost for protecting U.S. debt.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a credit-default swap protecting 10 million euros ($13 million) of debt from default for five years is equivalent to 1,000 euros a year.

Debt Crisis

Europe’s sovereign debt crisis took hold at the end of 2009 after a new government in Greece said the budget deficit was twice as big as the previous administration disclosed. In April, Greece asked to tap an EU-International Monetary Fund 110 billion-euro loan facility after being shut out of debt markets.

Germany’s biggest bond dealers say the worst is over for the region’s most-indebted nations.

Yields on government bonds of Greece, Spain, Ireland and Portugal will fall to within 2.2 percentage points of benchmark German bunds on average within the next two years from 4.61 percentage points last week, according to a Bloomberg News survey of 15 banks that trade directly with Germany’s debt agency. HSBC Holdings Plc, Europe’s largest bank by market value, Goldman Sachs Group Inc. and Societe Generale SA advise buying securities sold by Greece.

Austerity Measures

Bond dealers are confident that austerity measures will be enough to damp speculation the 16-nation currency union is in jeopardy of falling apart. Gross domestic product in the region will likely increase 1.7 percent this year instead of the 0.9 percent projected at the depth of the crisis in May, the European Commission said Sept. 13. Banks were given more time to raise capital levels to meet new regulations, reducing the likelihood they will need additional government aid.

“All the policy backstops have put a floor under the downside risks for peripheral euro-region bonds,” said Michael Vaknin, a senior fixed-income strategist in London at Goldman Sachs, which didn’t participate in the survey. “Spreads are near their records, but the EU and International Monetary Fund have pledged their support and opportunities are starting to emerge.”

Greece, Ireland and Portugal have the most expensive credit-default swaps of 21 bond markets tracked by Bloomberg data.

“It raises the risk of renewed contagion,” El-Erian wrote.

The record $248 billion Pimco Total Return Fund managed by Bill Gross returned 8.6 percent this year, beating 77 percent of its peers, according to data compiled by Bloomberg.

Pimco, which managed more than $1.1 trillion of assets as of June 30, according to its website, is a unit of Munich-based insurer Allianz SE.

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The Federal Reserve will cut its growth forecasts and Europe s economic bailout is failing, said Mohamed A. El-Erian, chief executive at Pacific Investment Management Co., which runs the world s biggest bond fund. U.S. central bankers may wait beyond their meeting tomorrow...
Monday, 20 September 2010 06:57 AM
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