Sunday, April 10, 2011

Bill Gross and The Road to Athens (Ruin)

Bill Gross is the co-CEO (along with Dr. Mohamed El-Arian) of Pacific Investment Management Co (or PIMCO for short). PIMCO oversees over $1.1 trillion in people's money. It runs the world's largest Mutual Fund, called the Total Return Fund. On Wall Street, when Bill speaks, people listen-- even more so when he acts decisively.. which he has just done over the last few months. Here's a chart of what the PIMCO has done with their investments over the last 3 years:

What's happening here is that Herr Gross is abandoning US Treasuries and going into cash-- in a very big way, more than he's done in years. Why ? In selling off his treasuries (and mortgage paper) he seems to be telling us that he believes the interest rates on US Treasuries will be going up and that the USD will be strengthening. Why would these two things happen at the same time, especially given that inflation seems to be raging at a dandy clip of late-- including tonite, with gold hitting (another) all time high with Crude, Silver and Corn all taking off to the moon ? He's telling us that there will be no more QE after June when QE2 ends. Given the extent of his positions in both cash and treasuries, it's apparent that Gross believes there will be a significant hike in the interest rates the US Gov't needs to pay to borrow money and that come June, the US Dollar will snap back, perhaps quite strongly. So what does this mean for the average working serf in America ? A strengthening dollar will mean that prices of goods such as gas and bread will come back down to earth-- good news for most of us working serfs. But here's the bad news: credit will be much harder to come by, helping to choke off any recovery. The US Gov't will begin to pay a higher and higher interest rate to borrow money. I look for the US Ten Year to approach 4.5% this summer. When this happens, the US Gov't has to pay more and more interest-- and thus will have to borrow even more to cover it's expenses as well as the added interest. More bad news: this will likely signal a pull back in the US stock markets-- but not a crash. In ending QE2 (and the repurchase of US bonds) Ben Bernanke is essentially saying to Obama "We've printed a couple trillion dollars to help you guys get over the hump. But now it's time for you to stop borrowing so much and get your house in order".  With all due respect, the US Gov't will never willingly do this. If Gross is right (and he almost always is) the US Gov't is about to be cut off from printing endless amounts of dollars to fund itself and we will be forced to make very serious cuts in spending, raise taxes (or a combination thereof) or our government will begin down the Road to Athens as interest rates on UST's go up and up. Here's the opinion of Lee Adler, a veteral Wall Street analyst who runs a rather expensive advisory letter to investors: “The evidence shows that banks are again out of the Treasury buying game. It also shows that they lost money in the first quarter, which is insane considering that their cost of funds is zero. It’s an indication of just how dire the circumstances are. Banks continue to accumulate cash at a frantic rate in their accounts at the Fed. The last time reserves rose this fast was in the midst of the crisis in 2008.
“Although the banks did buy some Treasuries in mid March, they have again stopped buying and reduced their holdings, opting to hold cash at the Fed instead. The banks are pulling cash out of the system and depositing it in their reserve accounts even faster than the Fed is printing it, lately 60% faster. We have to wonder what has them so spooked.
“At the same time, FCBs [foreign central banks] purchases of Treasuries are also backsliding, and are well below the threshold where they need to be to keep the markets stable. These elements essentially neutralize the Fed’s pumping. It may not be enough to send the
markets lower, and in the absence of new Treasury supply, Fed buying should be enough to keep the field tilted in favor of higher prices. April’s bias should be to the upside, but the background drag will be there. Things will get tougher in May when Treasury supply increases, and really tough this summer when the Fed presumably will stop pumping.” 

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