Apr 28th 2011, 10:33 by Buttonwood
SAY what you like about the fund managers at Pimco but they can come up with a telling phrase. Their latest note declares that
With quantitative easing, the Federal Reserve has in essence picked the pockets of Treasury bond investors throughout the world.
Now I am no great fan of QE but that seems to be a bit rich. Surely the Fed, by buying bonds and keeping yields lower than they would otherwise have been, has boosted the profits of bond investors. And it is not like the Fed has been secretive about the matter. Those who believe that this is a misguided policy know how much the Fed has been spending and when the programme will end; they have been perfectly at liberty to reduce their treasury bond positions (indeed the Fed has been facilitating such a strategy). Pimco has done just that.
Pimco develops its argument by saying that
The Fed has kept the demand for US Treasuries high, perhaps deceptively so, attracting with its redolence many classes of buyers, including households, banks, pension funds, insurance companies and foreign investors.
But hold on a minute. Not long ago, Bill Gross published a comment, favourably commented on in this column, which said that the Fed was buying 70% of Treasury bonds, with foreigners buying the rest. So American households, pension funds etc have presumably been buying fewer bonds than before.
Now Pimco goes on to argue that
QE promotes financial and economic conditions that hurts Treasury bond holders, primarily because it boosts economic growth and inflation, resulting in confiscation of the skimpy Treasury yields they earn. Foreign exchange investors have the added discomfort of a decline in the foreign-exchange value of the US dollar.
Those are more pertinent arguments, although again the Fed is providing such investors with an exit route if they want it. To the extent that QE is picking the pockets of anyone, I would suggest it might be
* the future taxpayer. By holding yields artificially low, there is less pressure for politicians to tackle the deficit and thus future taxpayers are saddled with extra debt. There is also the possibility that the Fed could suffer large mark-to-market losses on its T-bond holdings if inflation does soar; that taxpayer is ultimately liable.
* equity investors. If the stockmarket has been propped up by QE, as Ben Bernanke seems to argue, than prices are at an artificially high level. Those who buy at QE-boosted prices may lose money when support is withdrawn.
* investors in corporate bonds and those on fixed incomes. If Pimco is right and high inflation does result, that will cause damage to the portfolios even of those investors who have avoided Treasury bonds.
Nevertheless, I find it extraordinary that the largest private sector bond fund manager has such an aggressively downbeat view on the US market and I am surprised it hasn't received more mainstream attention or had more of a market impact. Still nobody can criticise Pimco for not speaking its mind.
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Future taxpayers: the interest rates are low, and some of that interest is taxed. So it benefits the future taxpayer, as long as the Fed holds the longer term bonds until maturity. If they try to dump them soon, prices go down, yields up. If inflation takes off, then the Fed earns a lower return for thier investment - inflation adjusted.
Equity investors: True, but they are responsible for thier actions. They get a higher return for taking more risks. Jumping on a locomotive is fine, timing the jump off before it hits the brick wall is another matter, but thier decision.
Investors in corporate bonds and those on fixed incomes: True again, but the risk/reward priciple applies again. Didn't Intel issue a long term bond that pays less than its stock dividend yield? Companies will need money in the future as they roll over older debts, so newer opportunities will arise at higher interest rates. Covertable bonds may be worth a look at.
I'm not surprised of the downbeat forecast. Interest rates basically have one way to go. The question is when.
Pimco is just the latest - and more noteworthy - person/institution to come out against bonds and Treasuries.
Remember how far ahead of the curve the Economist was on the US housing market going bust?
Regards
Pimco's speaking both their mind and their book. Remember - they sold out of treasuries a little while ago. What better than to help hammer them down than voice the reasons why.
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