Bill Gross Calls For Extreme On Rates (C, CFC, TLH, IEF, TLT)

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Bond seer Bill Gross of PIMCO issued his November outlook and is looking for the FOMC not to just need a rate cut this week.  He believes that the FOMC will need to cut short-term rates (fed funds) down to a whopping 3.5% in order to avoid a lending contraction not seen since the 1970’s (and even notes the 1930’s).

Bill Gross is a fixed income market hero.  A cut of this sort would undoubtedly help his own bond positions and values.  But regardless of his being able to win, his voice (and his peers) have been able to influence markets.  24/7 Wall St.’s take on this rate cut is that if this happens too rapidly, then the Fed runs the risk of turning a troubled dollar into a currency crisis not seen in decades.  We discussed on Friday the 100% chance of a 25 basis point cut and a small chance for a 50 basis point rate cut, based upon Fed Fund Futures contracts.  Our take is that a 4% funds rate would be an adequate wait and see level, mainly because even if rates go back to 1% there are still going to be many borrowers still in trouble.

The conclusion is as follows:
"……Ben Bernanke has no such luxury. While he does have the backstop of a global economy powering on at a 4-5% annual clip, today’s U.S. IPOs were more a creation of leverage and the shadow banking system’s ability to create productivity gains through finance, as opposed to technological innovation. With banks and their shadows in retreat and modern day “world saving committees” relatively impotent, Bernanke must do some heavy lifting as opposed to the light housework required of Alan Greenspan in 1998. An increasingly recessionary looking U.S. economy will likely require 1% real short rates and 3½% Fed Funds in order to stabilize a potential growth contraction in lending not witnessed since the early 1970s or, to be honest, Roosevelt’s depressionary 1930s. We can only hope that Bernanke, Paulson, and their cohorts recognize the danger and that the music keeps playing with the lights still turned on."

Gross noted Citigroup (NYSE:) and Countrywide (NYSE:CFC) specifically here.  The more active bond-related ETF is the iShares Lehman 20+ Year Treasury Bond (NYSE:TLT) is the bond ETF that traders flock to over interest rates because it tends to have the greatest price volatility from economic and market events. The other two are iShares Lehman 7-10 Year Treasury (NYSE:IEF) and iShares Lehman 10-20 Year Treasury Bond (NYSE:TLH).

Other excerpts from Gross are the following:

….If these credit conduits contract, then a Federal Reserve seekingto resurrect a faltering economy with 25 basis point cuts in interestrates may confront the same unmanageable response from the privatesector during an easing cycle, as it did during the past several yearsof steadily higher Fed funds.

….Mortgage write-offs, credit card losses, and increasing defaults onsmall business loans will squeeze bank balance sheets and incomestatements for the next several years. That pressure in turn willresult in more conservative lending practices, which will induce not acontraction in credit growth, but a noticeable slowdown.

….There’s nothing like the strong arm of new laws and/or newspaperheadlines to straighten the spine of a lender faster than you canpronounce “Barney Frank,” or “Gretchen Morgenson.” Ask Countrywide’sAngelo Mozilo how many marginal loans his company will be making nowthat he’s being publicly pilloried for personal stock sales thatallegedly got him out before public shareholders.

….So both old-fashioned banks and their derivative, conduit-fedshadow counterparts will be growing their balance sheets a lot moreslowly in future months and quarters. That rather immediatelytranslates into a slower economy and the need for government assistancein the form of lower interest rates or liquidity pushes like TreasurySecretary Paulson’s “Super SIV.” Whether Paulson’s “Committee to Savethe World – Part II” will succeed like Bob Rubin’s original during theLong Term Capital crisis is debatable. The idea, first of all, iscounterproductive because it continues to hide subprime asset prices inthe “shadows.”

Jon C. Ogg
October 31, 2007