Memo to the Fed: Hurt My Fund, Please
In more than three decades as a professional money manager, William Gross has built Pacific Investment Management Co. (PIMCO) into the world's largest bond-fund company with nearly $400 billion in assets. But with job growth accelerating again and interest rates still at 46-year lows, the king of coupon-clippers finds himself in the unusual position of advocating interest rate hikes that will likely whack the price of his bond holdings.
Gross says he would like to see Federal Reserve Chairman Alan Greenspan double the fed funds rate to 2% by November. Gross's flagship Total Return (PTRAX ) fund beat the market last year, delivering 5.1% to investors. So far in 2004, after rising in March, the fund is back to where it started the year.
BusinessWeek's Christopher Palmeri caught up with Gross on June 4, at the end of a week that brought him some good news. On June 1, New Jersey Attorney General Peter Harvey dropped PIMCO from a suit that accused it and related entities of allowing a big investor to make preferential trades in its funds. As part of a settlement, PIMCO's stock-fund distributor, which now operates under the name PA Distributors, and related entities never run by Gross will pay $18 million to the state. Both PIMCO and PA Distributors are units of German financial-services giant Allianz. Here are edited excerpts from their conversation:
Q: Congratulations on the charges against PIMCO [being] dropped. A:
Q: Congratulations on the charges against PIMCO [being] dropped.
A:Thanks. It's frustrating when you know what you've done, and no one else does. We're very thankful.
Q: You're asking Fed Chairman Greenspan for a rate hike. That's pretty unusual for a bond manager. Have you ever done that before? A:
Q: You're asking Fed Chairman Greenspan for a rate hike. That's pretty unusual for a bond manager. Have you ever done that before?
A:We've never had an economy where rates have been so low for so long and that stand a danger of producing additional asset bubbles, whether in housing or commodities. I haven't done this before, but it's fairly logical. A saver should want and should always ask -- demand -- that the central bank maintain as a high an interest rate as possible. That produces the highest returns for the saver.
Less-than-1% money-market rates have done nothing to enrich the net worth of mom and pop in Des Moines or PIMCO in Newport Beach. If the Fed raises rates, that puts more money in the pockets of American citizens and Pimco and institutional investors. In the short term, that puts pressure on bond prices. Those who own bonds will be upset with the price declines, but ultimately, from a pure economic view, the higher the rate, the better.
Q: What's the risk here if the Fed doesn't raise rates enough? A:
Q: What's the risk here if the Fed doesn't raise rates enough?
A:We have a 7% nominal gross domestic product growth rate. Normally, the short-term rate is close to the nominal growth rate. This divergence of [six percentage points] is more than stimulative. It's producing rampant speculation in all kinds of markets. The danger is that as the effect of asset inflation or inflation in general becomes obvious and the Fed has to raise rates, you'll see a decline in housing prices and all asset categories, including bonds and stocks.
It's like the old example of taking away the punch bowl [just as the party is starting]. This economy's punch bowl has been spiked by an assortment of vodka, gin, and distilled spirits of all kinds. When we take away this bowl, there are going to be negative consequences. It has been a hell of a party. But we're saying [to Greenspan] you have to act, the sooner the better.
It's like throwing a celebration at your home for thousands of guests, and it was obvious the guests were getting out of hand -- breaking antiques and furniture. It's time to send them home. It's time for Greenspan to call a cab for all the speculators.
Q: Greenspan has said he will raise rates. Your concern is that it won't be fast enough? A:
Q: Greenspan has said he will raise rates. Your concern is that it won't be fast enough?
A:Yes. He's a baby-steps guy. That's not to say he doesn't have valid reason for being cautious. Those reasons are as near as Japan, which produced a deflationary economy that didn't go anywhere for 10 years. They kept rates too high and raised them prematurely. That's his caution. He certainly is cognizant of the Japanese example, more willing to err on inflation than deflation.
This 1% [funds] rate is more than stimulative. If he moves to 2% in one fell swoop, it would simply be taking back the emergency decline we saw last year. That's the least they can do, take back that emergency rate. They can do it a quarter of a point at a time, until, by election time, it is back to 2%. That's still stimulative.
Q: Couldn't a hike of that magnitude have a big impact on say, housing prices? A:
Q: Couldn't a hike of that magnitude have a big impact on say, housing prices?
A:I think it could, and therein lies the reason for his caution. No one really knows. But a 1% federal fund rate is historically low, and 2% is just a touch above it. We have a 7% GDP growth rate -- that's a huge differential. If speculators are borrowing at even 2% and invest in a house going up at 5% to 10%, I don't think it will be a disaster.
Q: The Fed seems to be more intently signaling its plans to the market. Are you happy with that approach? A:
Q: The Fed seems to be more intently signaling its plans to the market. Are you happy with that approach?
A:We expect real content and signaling with each speech. I'm not suggesting [Greenspan has] gone too far. He has certainly gone to where signaling has become obvious to anyone. It allows the bond market to get ahead of the Fed. It allows Greenspan to observe the effect of higher rates. He's still at 1%, but they've signaled that rates are going higher.
Mortgage rates have climbed 75 basis points over the past six months. Greenspan has a key to the future. He can observe the economic impact of rate hikes without having done anything. That's a pretty good tactic. If the increase in rates shuts the economy down, he can quickly reverse his verbiage. The visibility is a good thing.
Q: Does the sudden surge in adjustable-rate mortgages concern you? A:
Q: Does the sudden surge in adjustable-rate mortgages concern you?
A:I thought it was remarkable that Greenspan would recommend adjustable-rate mortgages. I have been recommending them as well for the past few years. Over 5, 10, 15 years, those that borrow at short-term rates manage to pay less. That's what a positive yield curve tells you.
Q: At Total Return, you've been shortening your average maturity, buying more European bonds and keeping more in cash. A:
Q: At Total Return, you've been shortening your average maturity, buying more European bonds and keeping more in cash.
A:You want a shorter-than-average maturity, half-a-year less than market. You also want inflation protection. We're been buying TIPS [Treasury Inflation-Protected Securities]. We have a 6% position in TIPS. Third, if you have a reflating central bank, you want to invest in countries reflating the least. That's Europe and EC [the European Commission]. Our money has gone overseas.