Today the official Twitter account of bond fund PIMCO tweeted out the following:
That sure seemed random, but lest you think that this was some weird thought Bill Gross had that went from brain to Twitter too fast, the famous bond investor doubled down on the notion in an interview with CNBC.
In any case, to the extent that [Ryan] has criticised Ben Bernanke in terms of the dual mandate – i.e., focusing on employment in addition to inflation – going forward, given a 50-50 chance of him being the vice president, perhaps the selection of a future Fed chairman in January of 2014 might be related to another “hard money” type of outlook.
Ultimately, that’s good for bondholders, but in the short run, it means higher interest rates. So, perhaps there’s a little bit of a twist there in the last few days.
So Bill Gross is really standing by this idea that Mitt Romney’s VP selection has been a contributing factor to the rates rise.
And that’s really remarkable for two reasons.
1. The rise in rates started well before Paul Ryan was selected, and it’s a phenomenon that’s happening all around the globe.
You can see on this 3-month chart of 10-year Treasury rates that the bottom came in late July, well before Ryan was picked.
And here’s a chart of the German 10-year. Same deal: Rates bottomed in late July.
And just to drive home the point, here’s a 3-month chart of the Australian 10-year yield. Again, same deal. Rates bottomed in late July.
So this is NOT a US Federal Reserve phenomenon (because it’s way too global) and the timing doesn’t match the Ryan pick at all anywhere.
The real explanation for the rise in rates is simple: The data has improved marginally in the US, and the odds of a Eurozone collapse seem to have diminished, thus sapping some demand for safe-haven assets like US and German government Treasuries. The fact that rates bottomed at the same time as Mario Draghi famously said he would do what it took to save the euro, is quite telling.
OK, so maybe you’re thinking that Bill Gross doesn’t really believe what he says. He’s just trying to generate headlines and he has to come up with good lines for the media. And to be fair, aggressive media omnipresence is a big part of the PIMCO strategy for fundraising.
But here’s the thing, Bill Gross really does believe the essence of what he said in that tweet. How do we know that? Because the entire premise of the idea that a Paul Ryan-esque hard money approach to monetary policy would cause rates to increase has formed the basis of his market calls in recent years. And frankly, it’s the essence of a lot of what he’s gotten wrong.
And so that brings us to the second flaw of the above tweet…
2. It’s not only empirically incorrect (the recent market doesn’t back it up), it’s theoretically off the mark.
What Bill Gross is saying is that Paul Ryan’s existence on Mitt Romney’s ticket marginally decreases the odds of more QE or monetary easing at some point in the future. Maybe it would be a while before Bernanke got replaced by Ryan’s preferred hard money advocate, but anyone investing in 10-year Treasuries now would presumably take something like this into account, since 10 years is a long time.
But a hard money approach to monetary policy is not a reason for rates to rise. It’s a reason for rates to fall.
Conversely, quantitative easing calthough it involves the Fed buying up Treasuries, and thus theoretically depressing interest rates), actually causes rates to go up.
This can best be seen by looking at 2010, when QE2 was announced and launched in late summer, right around when the 10-year yield bottomed for the year.
We can be know for a fact that Bill Gross misread the connection between quantitative easing and the subsequent rate move, because this episode lead to his now infamous Treasury short in 2011.
On March 2 of 2011, he famously wrote that June 30, 2011 would be known as America’s next D-Day because after the Fed ended QE2, nobody would be around to buy Treasuries, and rates would surge.
Investors should view June 30th, 2011 not as political historians view November 11th, 1918 (Armistice Day – a day of reconciliation and healing) but more like June 6th, 1944 (D-Day – a day fraught with hope for victory, but fuelled with immediate uncertainty and fear as to what would happen in the short term). Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets. 15% gratuities may lie ahead, but more than likely there is a negative two-bit or even eight-bit tip lying on the investment table. Like I did 45 years ago, PIMCO’s not sticking around to see the waitress’s reaction.
He also famously asked: “The legitimate corollary question is: Who will buy Treasuries when the Fed doesn’t?”
Right around the same time, it was revealed that he was short Treasuries, but what happened?
Let’s go to the tape.
Rates didn’t surge at the end of Q2 2011. In fact they tanked.
Bill Gross’ famous bet against Treasuries in 2011 lead to one of the worst years of his career.
In October of that year, he event sent out an apology to his investors.
(And his investors had a right to be pissed. 2011 was an amazing year for US Treasuries, and yet the world’s biggest bond fund had tons of mum & pop investors on the completely wrong side of the trade, offering them no diversification from stocks.)
Backing up, it was all Bill Gross’ misunderstanding of the connection between QE and rates that caused the error. Bill Gross thought QE was keeping rates artificially low. If anything, rates have moved lower during periods of Fed inactivity in recent years.
And there’s a reason it works this way. QE is all about juicing growth and inflation. During periods of growth and inflation people don’t want to own fixed income Treasuries and so they dump them and the yields go up. When the Fed is sitting on its hands doing nothing, people are inclined to worry that growth and inflation will both go down, and they rush back into Treasuries, sending yields lower.
Bill Gross’ Paul Ryan tweet shows he still doesn’t see it this way. He still thinks of QE as a mechanism to depress rates, and still thinks that in the absence of QE, under a hard money regime, rates will rise.
What may sound like a hokey Bill Gross soundbite actually provides a big glimpse into his biggest missteps.