After an aside on why he doesn’t own a cell phone and the difficulty people who use them too much will have catching fireflies, PIMCO founder and CIO Bill Gross’ latest Investment Outlook explains the new paradigm that his bond fund is using to understand interest rates for at least the next three to five years: the New Neutral.
Bill Gross: New Neutral thesis gets some immediate confirmation from ECB’s negative rates
Riffing on PIMCO’s New Normal that explained rates in the aftermath of the financial crisis (just as Gundlach did with his own No Normal) the New Neutral argues that the financialization of the economy and high levels of leverage necessitate real policy rates around 0 – 50 basis points instead of the 2% – 3% range seen in previous decades.
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“It seems to me that the more finance-based and highly levered an economy is the lower and lower real yield levels must be in order to prevent a Lehman-like earthquake,” writes Bill Gross. While he is mostly discussing the US, ECB President Mario Draghi’s announcement that he was taking repo rates negative shows that the New Neutral has validity in Europe as well.
He argues that as prosperity becomes increasingly dependent on the price of money, as has happened in the US and most of the West, central banks have to keep the price of money low or they risk undermining that prosperity. Sometimes the rate will have to come up a bit because of deflation, but Bill Gross believes real rates will be close to zero for a long time.
McCulley argues that ‘new cash’ shouldn’t get an interest rate
But Bill Gross also takes the opportunity to highlight Paul McCulley’s return to the firm by explaining how he reached essentially the same conclusion in 2010. McCulley figured that the economy now has trillions of dollars in ‘new cash’ in the form of consumer credit, repo, Fed Funds, and more. Because so much of this money was related to finance, and not so much to the real economy, McCulley saw it as a payment method like cash and not as a store of value. If that’s true, it stands to reason that all this ‘new cash’ shouldn’t earn interest (just like cash doesn’t), though it could have around 50bp to account for the fact that interest rates are taxed.
McCulley and Bill Gross come at the problem from different directions, but they reach the same conclusion: investors need to prepare themselves for a lasting low interesting rate environment.