Pimco's Gross Talks Bond Market, U.S. Deficit and Europe Crisis

By: Bloomberg

Bill Gross, founder and co-CIO of Pimco, appeared on Bloomberg Television's "InBusiness with Margaret Brennan" today to discuss the bond market, the U.S. deficit and Greece being the top candidate for default in Europe. Gross says that Geithner gave the U.S. debt limit "wiggle room" and that QE3 will take the form of language instead of buying.

Gross also says that the IMF can do its job without Dominique Strauss-Kahn.

Gross on the ability of the IMF without Strauss-Kahn:
"I think they can. Institutions move on. This institution, certainly, there is a long history of providing appropriate policies for struggling emerging markets and now for Euro land at the periphery. Of course they can, the institution will live beyond demand."

On rumors that Mohamed El-Erian will take over Strauss-Kahn's role at the IMF:
"Goodness, no. Mohammed is firmly committed for the next 20 years. He said that he hopes that I outlast him, but I am sure that he will be there in 2031. I am not sure about myself."

On Greece needing more than $155 billion in aid:
"Hopefully they do that need more than $150 [billion]. Portugal and Ireland are in line for close to $100 billion themselves. It becomes a package of 300 to 400 billion euros in potential financing. Now it becomes a question of solvency as opposed to liquidity. Liquidity has been bolstered by the ECB over the past 12 to 24 months. Obviously investors and countries themselves are asking themselves if it is appropriate to expend additional funding for these countries that have abused their privilege at the borrowing line. That is a decision that they have to make. We suggest going forward that Greece is insolvent and at some point the can cannot be kicked down the road any further. It may be sooner now rather than later what that means. Definitely Greece is insolvent and needs funding from the FSF and a lifeline. Ultimately, debt holders are going to have to bear some of the burden as well."

On Greece being the one country to default in Europe this year:
"Certainly. They are the number one candidate. Ireland and Portugal do have similar situations in terms of high debt to GDP and similar situations in terms of negative growth looking forward, which is the ultimate problem…Debt holders should be looking to analyze whether or not a country can grow again. It appears that Greece, because of the stringent fiscal measures that have been implemented, cannot get above the line in terms of real growth. Ultimately that means that since they're paying 5% to 7% on their debt through the ECB and the EFSF, they will have to be able to grow above that, nominally or in real terms to pay that back and to stop the deficit and debt levels from increasing as a percentage of GDP. It appears as they can't do that."

On Treasury Secretary Geithner's action to stave off the debt limit until August:
"Secretary Geithner has given some wiggle room as we know. Perhaps as in August and to some extent, as Republicans might wonder, it may be later than that, but it is a short time ahead. It should be taken seriously in terms of the United States' credibility and their status as the reserve currency and their ability to lead financially going forward. It is no joking matter and should be resolved shortly."

On if it was politically imprudent to allow wiggle room until August:
"Perhaps. I am sure that he would want it back in terms of the first line in the sand and now the second, supposedly. I truly feel the second line in the sand is fairly firm, to the extent that from that point forward it becomes a question of expenditures versus interest on debt and the reissuance on debt. To my way of thinking it is critical that the latter category be maintained in terms of reputation, its solvency, its reputation going forward."

On the debate being more than politics at this point:
"I think so. The ability to make good on your debt is a longstanding policy of the United States, some would argue that in the early 1930s, going off of the gold standard so to speak, that was a default, but really the United States has never done it and other countries have. We are the reserve currency. We are the most liquid market, the most fungible market in the world and to put that in jeopardy would probably jeopardize the status of the dollar, first of all. The bond market wouldn't do well either. It is mainly the dollar through which financial transactions are taking place on a minute to minute basis and the reputation of the United States as the reserve currency that stands behind it."

On if he is short on Treasuries:
We are not. To a certain extent, it may be our fault because we have a category in terms of our monthly release that is called treasury or treasury related securities. It could be Treasuries, it could be agencies, it could be swaps which sophisticated bond investors know are entirely different from Treasuries so the extent that it shows up as a short then it's almost entirely been in the swap category as opposed to the Treasuries. The Total Return Fund has had tens of billions of dollars worth of treasuries, to some extent in short-term Treasuries and bills and and collateralized repo. It has never been a question of Pimco in terms of the Treasury's reputation and its potential to default. It has always been a question of value in terms of interest rates relative to other alternatives."

On if he'll change his position on bonds at this point:
"No, you have to look at it from the standpoint of the economy going forward and what inflation is going to be, to the extent that the economy slows and inflation comes down to support the Treasury market. As we know, for the past several years Treasuries have been supported artificially by QE1 and QE2, and as well by Chinese and other large reserve holders. To a certain extent that suggests an artificiality to yield levels. The Federal Reserve of New York has estimated 50 to 100 basis points of under-yielding, over-priced valuation from these programs in combination. If that is the case, it means that investors are receiving less than they should and they should look for alternatives."

On what happens to the credit markets at the end of June when QE2 stops:
"It is a large question. The Fed, I am sure, does not really know and Pimco has question marks to. We simply suggest that since the Fed has been purchasing 70% to 75% of all the Treasuries that have been offered over the past year, year and half that it's a legitimate question of who will buy them and at what yield. We simply think that Treasury yields have been artificially repressed not only by QE1 and QE2 but by the policy rate. The policy rate of 25 basis points, Fed funds, has been there for over two years now and to the extent that Fed officials--Bernanke and others--think that it will remain there for the next 6 to 12 months, then that becomes a follow-on to QE2. What we sense is going to happen is language will dominate policy going forward and that investors will take comfort from an increasing amount of language that suggests an extended period of time."

"Based on the language that we will see after june 30, if the fed continues to suggest that unemployment is a priority and inflation is contained, then you can expect fed funds to stay at 25 basis points. That's a very significant anchor. Follow the policy language going forward, expect QE2 to end and expect QE3 to take the form of language as opposed to actual purchases of Treasuries going forward."

"We like headline over core. Some Fed officials have basically suggested that headline is what the Fed really focuses on and core a reflection of where they think headline is headed. We think otherwise that headline has been influenced and will continue to be influenced by commodity based decisions from countries in the developing as opposed to the developed world. As long as that demand continues, you can expect a continuing divergence between core and headline, though the Fed expects otherwise."

bloomberg.com

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