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Pimco's Gross: Fed has succeeded, but U.S. still faces permanent slump

When the Federal Reserve meets this week, the Wall Street Journal reports the most challenging question won’t be where to push interest rates in the near term, but where they belong years into the future. The WSJ indicates policy makers have believed the benchmark interest rate — known as the federal-funds rate — should be about 4% in a balanced economy, but officials are now debating whether interest rates need to remain below that threshold long after the economy returns to normal (i.e. once inflation is stable at 2% and unemployment around 5.5%).

Related: Fed Chair Yellen signals she is less concerned about this economic threat: FT Alphaville's Garcia

Pimco, the world's largest bond manager with close to $2 trillion in assets under management, believes the federal funds rate will remain well below the "neutral" policy rate of 4% once the economy returns to full health. The firm is predicting a "new neutral" rate of 2% (nominal), given the highly leveraged economy. In the video above, Pimco founder and CIO Bill Gross says the difference is "critical" as the neutral policy rate "basically determines the prices of all assets."

He tells us the biggest investment theme for the next five years will be, "how far does the Fed go in terms of their tightening and their journey back up, as opposed to down," as the central bank moves to get out of the business of buying treasury bonds and mortgage-backed securities, and begins to raise rates from near zero.

The head of the International Monetary Fund on Monday said the Fed should move rates up only gradually when it finally begins to lift borrowing costs, Reuters reports. 

While tightening may be the next phase of the monetary policy story, what does Gross think about the impact of the Fed's easy money policies and how successful they have been over the last five years -- with rates held near zero and the balance sheet expanded by trillions of dollars?

Related: Why the Fed taper isn’t reversing monetary policy trends

He says, "so far, so good." Gross credits the Fed for over five years of "beautiful deleveraging," as hedge fund titan Ray Dalio calls it. Gross also sees success in other factors, including real economic growth of 2%, institutions being shored up, the stock market being close to record highs and employment growing at 200,000 a month. He says it remains a legitimate question what the central bank can do when it stops buying bonds and starts raising rates, though, conceding that things could get ugly.

And while 2% growth is less than stellar considering a historical norm of 3.5% to 4%, the lower growth is inline with what Pimco dubbed the "new normal" for the economy back in 2009. More recently, economists such as Larry Summers have advanced the idea that the U.S. may be facing secular stagnation -- a permanent slump, with the economy hindered by structural issues such as demographics and the automation of jobs.

 Related:  Has the U.S. Economy Entered a ‘Permanent Slump’?

In the video below, Gross says he agrees we are in a secular stagnation period and says it is difficult to get out of. He jokes that Summers "took our [new normal] idea and called it secular stagnation," adding, "come on, Larry ... give Pimco some credit!" Check out the bonus video for more.

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